London, Europe Brief News – The ripple effects of the Ukraine crisis have disrupted energy and food markets. Among many other factors, supply chain disruptions and price spikes in key commodities have been pushing the world towards a precarious inflationary surge.
This will have immediate and devastating effects on household welfare—with those in poverty and near-poverty typically hit hardest due to their higher energy and food budget share— posing significant policy challenges to governments during the response.
To win an economy that works for people and planet, we need a new approach to inflation.
Food and energy response
Facing high debt levels and rising borrowing costs, policymakers should prioritize targeted support through social safety nets to the most vulnerable people. In some countries, this might entail providing discounts on utility bills (for basic usage) to vulnerable low- and middle-income families. Allowing energy prices to adjust is crucial to preserving broader incentives to curb energy use and increase supply. Faced with long-lasting supply shocks and broad-based inflation, governments should not attempt to limit price increases through price controls, subsidies, or tax cuts. Such a move would be costly to budgets and ultimately ineffective. With limited resources, many low-income countries will need greater global efforts in humanitarian assistance and emergency financing.
In a time of high inflation, policies to address high food and energy prices should not add to aggregate demand. Demand pressures force central banks to raise interest rates even higher, making it more expensive to service government debt. A tightening fiscal stance sends a powerful signal that policymakers are aligned in their fight against inflation.
Fostering economic resilience
Our report highlights that governments need to build resilience over time to a range of adverse shocks. The pandemic and the global financial crisis have shown that governments must prepare for rainy days. Building fiscal buffers gradually would eventually allow policymakers to respond swiftly and flexibly to crises.
Several fiscal tools that have proved useful during the pandemic can be made part of a more permanent toolkit, depending on countries’ capacity and available fiscal space. Job-retention schemes, for example, proved effective during the pandemic by stabilizing more than 40 percent of individual income loss in the European Union. Exceptional financial support to companies can prevent widespread bankruptcies. But such support should be reserved for severe crises as it exposes governments to sizable fiscal risks.
More generally, social safety nets help people bounce back from unemployment, sickness, or poverty, making them more resilient to a broad set of challenges. Such systems can be made readily scalable and better targeted with the help of digital technology.
We have seen how major global crises during the past decade-and-a-half have led to innovative and forceful fiscal responses. Countries should rethink the role of fiscal policy in a shock-prone era and learn from experiences across the world.