Economic Analysis and Policy 69 (2021) 340–349

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Economic Analysis and Policy

journal homepage: www.elsevier.com/locate/eap

Analyses of topical policy issues

The global fiscal response to COVID-19: Risks and

repercussions
∗
Anthony J. Makin a , , Allan Layton b
a
Economics, Griffith Business School, Griffith University, Gold Coast, Australia
b
Faculty of Business and Law, University of Southern Queensland, Springfield, Australia

article info a b s t r a c t

Article history: Governments around the world responded to the COVID19 crisis (CVC) by aggressively
Received 11 September 2020 deploying fiscal policy to boost health expenditure, income transfers and increased
Received in revised form 13 December 2020 welfare payments, as well as wage subsidies to firms to retain employees to minimize
Accepted 13 December 2020
short term unemployment. A fiscal response was in principle both necessary and timely,
Available online 17 December 2020
but the nature of the responses adopted by governments differed markedly around the
Keywords: world. After describing the global macroeconomic impact of the CVC and its effect on
COVID19 crisis budget deficits and public debt levels, this paper critically evaluates the global fiscal
Fiscal policy response response with reference to comparable historical episodes. The analysis suggests some
Public debt fiscal responses were too expansive and of the wrong form. The paper then highlights
the future macroeconomic risks arising from the highly elevated public debt levels the
CVC has caused, concluding that fiscal consolidation rather than further fiscal ‘stimulus’
will be needed to address the parlous fiscal legacy of the crisis.
© 2020 Economic Society of Australia, Queensland. Published by Elsevier B.V. All rights
reserved.

1. Introduction

A century after the Spanish Flu, the COVID-19 pandemic has wreaked economic havoc on the world economy. No
university textbook analyses a health-related economic shock of this kind, which has resulted from government-mandated
border closures and lockdowns. The closest analogy is to government command and control of economies in wartime, in
this case with the virus as the foreign invader.
The economic shock stemming from the coronavirus crisis (hereafter the ‘‘CVC’’) first disrupted supply chains from
China before bans on international travel hit airlines, cruises and tourism. Next, government mandated lockdowns and
physical distancing restrictions closed entertainment, restaurants and recreational outlets as well as office-based work in
a wide range of service industries, with negative spillovers to other industries.
Textbooks usually analyze economic shocks as either aggregate demand shocks (financial crises, investment slumps,
export booms) or aggregate supply shocks (oil price fluctuations, productivity changes, wage hikes), stemming mainly
from aberrant private sector behavior, or natural disasters.
However, the CVC was simultaneously an aggregate supply and aggregate demand shock, caused by deliberate
government action, disrupted supply chains and altered household and business behavior which would have occurred
regardless of lockdowns. Aggregate supply contracted massively, first due to supply chain disruption, then forced business
closure, while aggregate demand collapsed due to employment-related income loss, restrictions limiting household
consumption, and heightened uncertainty about the future.

∗ Corresponding author.
E-mail address: [email protected] (A.J. Makin).

https://doi.org/10.1016/j.eap.2020.12.016
0313-5926/© 2020 Economic Society of Australia, Queensland. Published by Elsevier B.V. All rights reserved.
A.J. Makin and A. Layton Economic Analysis and Policy 69 (2021) 340–349

Had there been no government-imposed lockdown restrictions recessions could still have eventuated in pandemic
afflicted economies. For instance, Japan and Sweden avoided the severe lockdowns imposed in many other advanced
economies but experienced 8 per cent and 9 per cent economic contractions respectively in the June 2020 quarter.
An interesting and much neglected historical economic fact is that there was no fiscal stimulus response to the
forgotten, albeit short-lived, depression in the United States in 1920–21, just after the Spanish flu pandemic, and around
a decade before the Great Depression. At that time there was a close to one third fall in US industrial production, a near
halving of the Dow Jones Industrial Index, a collapse in corporate profits, and a sudden rise in unemployment.
Instead of fiscal stimulus, the administrations of Presidents Woodrow Wilson and Warren Harding responded by
balancing the federal budget, while the Federal Reserve raised interest rates instead of lowering them. Within eighteen
months that depression was over.1 Times and the structure of economies have changed markedly since then of course, a
key difference being that economies are now more internationally integrated.
The COVID-19 crisis (hereafter the CVC) elicited extensive and immediate policy responses from governments around
the world. These centered on preventative and palliative health measures, as well as extensive macroeconomic policy
responses in the form of fiscal and monetary support for struggling businesses. This paper focuses mainly on the fiscal
responses to the CVC.
In advanced, developing and emerging economies the virus has predominantly harmed the effective operation of firms
and their employees in the private sector, with public sector activity and employment much less affected. Hence, fiscal
policy responses to the CVC have been directed toward keeping business afloat to minimize short term unemployment.
In principle, a fiscal response was both necessary and timely. However, questions arise about whether fiscal responses in
some countries were too expansive, of the right form, and whether generous cash handouts to encourage consumption
spending should have been included.
The remainder of this paper is organized as follows. Section 2 examines the macroeconomic impact of the CVC on the
world economy, compared with previous crises, before outlining the consequences for budget deficits and public debt.
It then critiques forms of the fiscal response. Next, it canvasses theoretical linkages between public debt and economic
growth and highlights the economy-wide risks of the elevated public debt. The paper concludes with recommendations
for fiscal policy going forward, including cautioning against further ‘stimulus’ measures.

2. The macroeconomic impact of the CVC

The last major bout of fiscal activism was the response by governments around the world to the 2008–10 Global
Financial Crisis (GFC). The response to the pandemic therefore invites comparison with that earlier episode and historic
Depressions. Although the GFC and CVC can both be termed external shocks, they have been transmitted quite differently.
The GFC was an external financial shock similar to the Asian financial crisis of the late 1990s which impacted on the real
and financial sectors of economies via cross-border trade and financial sector linkages.2
During the GFC, North Atlantic region banks, global stock markets and commodity prices collapsed, as did exchange
rates for non-safe haven currencies. The CVC in contrast was an externally sourced health disaster which prompted
necessary preventative measures by governments that, in turn, severely curtailed economic activity and drove up
unemployment. Stock markets initially reacted by plummeting, before partially recovering, yet continued to gyrate
according to investors’ perceptions of how long the health crisis and government restrictions on economic activity will
last.

2.1. Pre-CVC economic performance

Before the pandemic, advanced economies had been experiencing significantly lower economic growth than prior to
the GFC. Real wage growth had also generally been sluggish, a key reason being that private investment in advanced
economies, which acts as conduit for productivity growth by embodying the latest technology, has been anemic.
Private investment worldwide has been weak post GFC for a number of reasons, including more restrictive bank credit
conditions imposed on business and increased uncertainty stemming from the global public debt overhang that resulted
from excessive GFC fiscal stimulus measures. Public debt was already at a level unprecedented in peacetime before the
pandemic yet continues to grow unabated worldwide due to the CVC fiscal response.
Meanwhile, emerging economies, notably in Asia, contributed strongly to post-GFC world growth, accounting for up to
two thirds of global economic growth, driven in particular by populous China, India and Indonesia.3 . Unlike the advanced
economies, emerging Asia avoided recession during the GFC, and coped better with the post-crisis global downturn. Within
the advanced economies grouping, Japan and Western Europe have notably experienced economic growth persistently
below pre-crisis rates. A recession due to the CVC was inevitable, although a worldwide depression remains unlikely.

1 See Grant (2014).

2 Makin (2018) elaborates.
3 International Monetary Fund (2020).

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Fig. 1. World Economic Growth, annual percent change.

Source: IMF, World Economic Outlook.

Fig. 2. Projected World Economic Growth: Q1, 2019 = 100.

Source: IMF, World Economic Outlook.

2.2. The great lockdown recession

The International Monetary Fund (2020) estimated a near 5 per cent drop in world growth from the Great Lockdown
response to the virus, followed by a rebound a year later. See Fig. 1. IMF assumed similar financial conditions prevailing
pre-CVC would continue, including financial market valuations, notwithstanding those valuations being quite at odds with
economic fundamentals, implying a clear downside risk to the IMF projections.
As Fig. 2 shows, the IMF assumed a V-shaped world economy recovery after just two quarters of contraction. This
suggested a relatively short Great Lockdown Recession (GLR), representing the minimum duration required for an
economic downturn to be termed a recession. The Great Recession post GFC was considerably longer, at 18 months
duration for the United States in particular.
Fig. 1 also shows IMF growth projections for the major country groupings. The world’s advanced economies are shown
to have experienced a much deeper contraction (at an average eight per cent) than the rest of the world. Indeed, for the
advanced economies the IMF estimated economic output and income would remain lower than a year before CVC struck
for several years afterward. Recession and recovery in advanced economies is however mitigated by a shallower recession
and stronger recovery in the rest of the world, especially in emerging economies.
This global economic growth picture was predicated on extraordinary macroeconomic policy support, fiscal and
monetary, provided by policymakers around the world. While the focus of this paper is on the global fiscal response, it
is important to note that the world’s central banks also implemented massive financial support measures. Central banks
in unison reduced official interest rates to historic lows, even compared with the GFC, many dropping to near zero with
some official interest rates becoming negative.
Beyond that, several central banks engaged in Quantitative Easing (QE — expanding the financial system’s liquidity
through central bank purchases of government bonds, colloquially referred to as ‘‘money printing’’). A few even expanded
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Fig. 3. Overall Fiscal Balance, percent of GDP.

Source: IMF, World Economic Outlook.

QE activity to buying private sector corporate bonds in addition to government bonds, for instance, as did the US Federal
Reserve, the Bank of England and the European Central Bank.
Detailed analysis of the global monetary policy response is beyond the scope of this paper, although we note that
the sizeable monetary expansion that has occurred has longer term implications. In particular, it raises serious future
macroeconomic risks, including a sudden correction to asset prices inflated by extremely cheap money, and the onset of
higher subsequent goods and services inflation as economic activity picks up.
The monetary policy response in some countries, Australia and the United States was however conceivably less
than optimal. By forecasting low inflation many years hence, the Reserve Bank of Australia and Federal Reserve have
conditioned expectations for future inflation that are unrealistically low. Reflecting this, long-term inflation expectations
derived from the bond market and surveys suggest inflation will stay very low for an indefinitely long time.

3. The global fiscal policy response

Governments responded aggressively to the pandemic using fiscal policy that entailed additional spending and tax
relief. The ensuing large fiscal deficits reflected the extent to which the world’s governments spent over and above
their revenue, sourced mainly from a range of taxes. The sharp 2020 budget deficit spike resulted from the usual
drop in corporate, income and value added tax revenue during recessions, increased welfare payments due to higher
unemployment, and overt support measures governments put in place to support individuals and businesses due to the
CVC.

3.1. Budget deficits blew out

Fiscal support measures around the world ranged from additional welfare payments to individuals, the provision of
grants to small businesses across the board or in designated industries/sectors, payments to firms to retain staff in the
face of greatly reduced, or zero, demand for their products and services, as well as other measures such as provision of
concessional childcare.
Fig. 3 shows the scale of the global budget deficit blow-out from the CVC. At the world level, the IMF estimated a
peak global fiscal deficit of around 14 per cent of world GDP in 2020, a 10 percentage point rise in deficit on the previous
year. This was almost three times the deficit following the GFC, with the significant deficit reduction from 2020 reflecting
an assumed short deep recession followed by gradual recovery.
Most of the global fiscal support emanated from the advanced economies group, with their fiscal deficit peaking
at almost 17% of group GDP, a five-fold increase from the previous year. Meanwhile, the emerging and low-income
economies experienced relatively less fiscal stress, although for both these groupings budget deficits were much higher
than historical norms.
Fig. 4 shows the actual improvement in the global fiscal deficit was much less after the worst of the GFC had passed
than what the IMF was projecting post-CVC, suggesting a significant downside risk to the IMF’s post COVID fiscal outlook.
Not included in the data behind Figs. 3 and 4 are a range of ‘‘off-balance sheet’’ support measures, most notably
official loans and government guarantees for bank loans. See Fig. 5. The IMF estimated total global government support
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Fig. 4. Change in Overall Fiscal Balance, percent of GDP: GFC versus CVC.
Source: IMF, World Economic Outlook.

Fig. 5. Fiscal Measures in Response to CVC, percent of GDP: Country Groups.

Source: IMF, World Economic Outlook.

amounted to around US$11 trillion, with around half of that in the form of off-balance sheet assistance. To the extent
these off-balance sheet loans – as contingent liabilities of governments – are not re-paid, they will exacerbate nations’
fiscal imbalances.
Advanced economies (AEs) provided most loan support, with more than half the total government support provided
this way. In contrast, government support provided in emerging (EMs) and low-income developing countries (LIDCs) was
mostly on-balance sheet fiscal support.

3.2. Public debt escalated

Budget deficits are annual flows that add to a nation’s stock of government or public debt. In the wake of the GFC,
public debt escalated due to higher budget deficits stemming from falling revenue and increased government spending to
counter recession,4 exacerbating already high public debt levels in many economies, especially in Southern Europe and
Japan. Before the pandemic public debt levels were therefore already high around the world.
Global debt, private plus public debt, stood at a record high of around 225 per cent of world GDP pre-COVID, some
12 per cent higher than before the GFC. Global debt was mostly owed by advanced economies which went in to the GFC
with already historically high public debt levels. Developing economies in Asia contributed significantly to the post-GFC,
with China alone being responsible for under half of the rise (IMF, 2018).
Fig. 6 illustrates the impact the extraordinary fiscal policy support measures have since had on the world’s public debt
level and can be seen to far exceed the jump that occurred post GFC.

4 See Spilimbergo et al. (2009).

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Fig. 6. Change in Government Gross Debt, percent of GDP: GFC versus CVC.
Source: IMF, World Economic Outlook.

Fig. 7. Gross Government Debt, percent of GDP.

Source: IMF, World Economic Outlook.

Reflecting the larger fiscal deficits in advanced economies, public debt ballooned substantially more, with their
post-CVC government debt levels some three times higher than those of the poorest economies (refer to Fig. 7 below)

4. How effective were fiscal policy responses?

Keynes (1936) most famously advocated fiscal stimulus in the form of increased spending on infrastructure (then
called ‘public works’) during The Great Depression of the 1930s, the result of a massive stock market and banking system
collapse that severely contracted money supplies in major industrialized economies.
However, the academic jury is still out on how effective it was. Some argue that the uncertainty it created for
business actually prolonged the Depression, at the same time as economies turned in on themselves and became
highly protectionist.5 Ever since then Keynesian fiscal activism to stabilize national income and hence employment has
historically biased government spending upward because higher public spending during downturns is rarely subsequently
reversed by lower spending as economic conditions improve.

5 See Baker et al. (2016), Higgs (1997), Temin (1991) and Makin (2015) for related discussion.

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4.1. Fiscal stimulus versus fiscal relief

In judging fiscal responses, it is important to distinguish between elements that are in the nature of fiscal stimulus and
those in the form of fiscal relief. The dictionary meaning of stimulus is something that rouses activity, and in the fiscal
context, has come to mean meaning deliberate budgetary action via higher public spending, tax cuts, cash handouts, or
more generous social welfare payments to rouse economic activity.
Fiscal stimulus is aimed at the demand side of the economy and is supposed to work by increasing total spending to
reverse any unexpected economy-wide downturn. Alternatively, fiscal relief is primarily directed at the supply side to
stabilize production via tax breaks, although tax breaks can have secondary demand effects that lead to future output
gains. For instance, when company tax cuts or investment allowances induce higher investment.
To characterize the bulk of business-oriented fiscal responses to the CVC ‘Keynesian’ and similar in nature to the
Keynesian fiscal response to the GFC is misleading. There is a clear difference between Keynesian advocacy of direct
government spending and cash handouts to boost aggregate demand in the economy, and business tax relief measures to
counter a government mandated aggregate supply collapse, albeit with some attendant aggregate demand consequences.
A significant portion of the fiscal packages announced to counter the economic impact of the CVC were therefore not
stimulus as such because they did not rouse economic activity but aimed instead to keep economies and supply chains
on life support. Hence terming these packages fiscal stimulus was a misnomer.
The guiding principle in crafting a fiscal response to any crisis should first and foremost be fiscal relief that temporarily
lightens the burden of government on the supply side of the economy, predominantly consisting of small and large
business. Business creates the most jobs in the economy and it is where productivity and real wage-enhancing investment
decisions are made.
Corporate tax breaks for instance provide fiscal relief for business that can counter falling profitability and laying off
workers, though would unlikely rouse economic activity under crisis conditions. In this way fiscal relief differs markedly
from fiscal stimulus of the crude Keynesian type, aimed at bolstering the demand side of the economy, via increased
government spending in various forms, including cash transfers to increase consumption.
The benefit of corporate tax relief to companies hardest hit by the CVC is limited due to the lower resultant profitability.
This suggests accelerated investment allowances and write-offs, as well as loss ‘‘carry back’’ tax provisions that allow firms
to claim CVC-related losses against assessed taxable profits in previous years, as adopted by the Australian government,
are more effective fiscal relief measures.
To characterize the bulk of business-oriented fiscal responses to the CVC Keynesian and similar in nature to the
Keynesian fiscal response to the GFC is therefore misleading. In short, direct government spending and cash handouts
to boost aggregate demand in the economy differ markedly from business tax relief measures to counter a government
mandated aggregate supply collapse.
Arguably, direct temporary government subsidies paid to private firms to preserve employment, as adopted in many
advanced economies including Australia, New Zealand and the United Kingdom, are also a form of fiscal relief as they
target the production side of economies. While there have been flaws in the operation of these wage subsidy programs
which have come at a great fiscal cost, in principle they have been more justifiable than the other crude Keynesian
elements of the fiscal response aimed at boosting aggregate demand.

4.2. Does fiscal stimulus work?

Both fiscal relief and fiscal stimulus necessarily mean bigger budget deficits and higher public debt, key macroeconomic
variables Keynes incongruously left out of his theory. But therein lies the reason why fiscal stimulus in particular most
likely douses, not rouses, economic activity in net terms once longer terms effects further down the track are properly
taken into account. This is because fiscal stimulus in the form of higher government spending aimed at raising aggregate
demand has offsetting effects elsewhere in the economy that eventually neuter its impact.6
More public spending raises the budget deficit and of course the share of government spending in total spending
in the first instance. Yet government spending is but one component of total spending and, as standard undergraduate
textbook theory suggests, for an economy with well-developed, internationally integrated financial markets, offsetting
falls in private investment and/or net exports will subsequently occur because the bigger budget deficits and the issuance
of public debt either crowds out private investment or entices capital inflow from abroad, leading to a higher exchange
rate and lower net exports.
The GFC fiscal response was ‘stimulus’ of the Keynesian kind. Yet there is copious academic evidence to suggest
fiscal stimulus fails in open economies like Australia, especially over the medium to longer term, due to the inevitable
macroeconomic costs it imposes. These costs arise through a stronger exchange rate driven by capital inflow if government
spending is relatively higher than abroad.7
How monetary policy responds under these circumstances influences the impact of fiscal policy as expansionary
monetary policy can mitigate exchange rate appreciation. In Australia’s case the pandemic response has been weighted
more to fiscal instead of monetary policy leading to a significant strengthening of the exchange rate. This suggests a
stronger monetary policy response was warranted in Australia in the early stages of the crisis.

6 Makin (2018) elaborates.

7 Makin (2010, 2019) examines Australia’s fiscal response to the GFC.

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4.3. Are cash transfers effective fiscal policy?

A key element of many advanced economies’ CVC fiscal responses which was in the nature of old-style Keynesian
stimulus was the provision of cash handouts, or income transfers paid to households, including pensioners and other
welfare recipients, to encourage household spending. Why governments chose this fiscal option is puzzling for several
reasons.
First, it was at odds with government health restrictions, including stay-at-home advice and limits on the provision
of goods and services to essential services. Second, economic theory suggests that, as those payments were one-off and
hence temporary, they were more likely to be saved than spent, yet at significant cost to government saving. On the
other hand, if they were spent, it effectively means governments were borrowing to fund private consumption, with no
matching asset accumulation in government balance sheets.
For countries that have characteristically been external borrowers over recent decades, including the United States,
United Kingdom, Canada, Australia and New Zealand, this implies additional net borrowing from abroad and corresponding
worsening of current account imbalances.

5. Public debt and economic growth

The fiscal response to the GFC, co-ordinated worldwide via the Group of Twenty economies (G20), spawned a huge
empirical literature that yielded mixed results focused mainly on estimating various fiscal multipliers.8 There has been
far less attention paid to the longer run effect of past fiscal deficits and higher public debt on economic growth, which is
critically important to the sustainability of public debt to GDP ratios into the post-CVC future.

5.1. Theoretical linkages

There are several macroeconomic channels through which public debt can influence economic growth.9 First, according
to the classic loanable funds approach, budget deficits that generate higher public debt increase the demand for funds
which, other things equal, pushes up domestic interest rates. This crowds out private investment which limits expansion
of the economy’s capital stock, a key driver of economic growth.
High public debt fueled by unproductive deficit spending can also harm business and household confidence and create
uncertainty about how public debt will be paid down via fiscal repair, which is inimical to private investment and durable
economic growth. There is a major inconsistency in macroeconomic thinking that fiscal deficits are justified according to
crude Keynesianism whenever ‘‘animal spirits’’ are weak.
Animal spirits are really only business confidence by another name, and when budget deficits are wound back via cuts
to unproductive spending, business confidence should improve, which in turn bolsters private investment, work effort,
and productivity. As a result, economic growth is bolstered in the longer term.
Meanwhile, the Ricardian Equivalence (RE) proposition implies crowding out of private consumption as households
save to meet future tax obligations to repay public debt.10 The RE proposition, which is closely related to the precautionary
motive for saving, suggests that when faced with budget deficits, households, wary of future taxes that could be raised
to pay off public debt, will save rather than spend. Numerous empirical studies for a range of economies at all levels of
development show that the extent of the offset of private for public saving is in the range of 0.5 to 1.0.11 That implies a
one dollar increase in public debt is offset on average by reduced consumption of up to one dollar.
Private saving will also rise to offset reduced public saving if households perceive cash transfers aimed at increasing
consumption as transitory income, consistent with the permanent income theory of consumption (Friedman, 1957). If
private saving fully offsets public saving, total saving therefore remains unchanged. Hence, other things equal, private
investment remains unaffected, as does the current account imbalance. On the contrary, to the extent firms expect higher
public debt means higher company tax, investment could actually fall rather than be ‘crowded in’ due to increased
uncertainty dampening future growth.
Relatedly, the intergenerational inequity argument suggests it is unfair for future generations to repay public debt
incurred by the present generation simply to maintain its own consumption, although this is unlikely to affect economic
growth per se.12
Additional long-term risks stemming from the large CVC-related budget deficits are that governments will resort to
financial repression to manage the escalation of public debt. This would impose efficiency costs on the economy due to
the misallocation of capital on top of the future deadweight loss from higher future taxation. Another is that governments

8 See, for instance, Mountford and Uhlig (2009), Auerbach et al. (2010), Cogan et al. (2010), Kollmann (2010), Ramey (2011),Woodford (2011),
Davig and Leeper (2011), Ravn et al. (2012) and Guest and Makin (2013).
9 Makin (2018) elaborates.
10 See Barro (1974) and Seater (1993).
11 See Loayza et al. (2000) and Makin and Narayan (2011).
12 See Modigliani (1961), Meade (1958) and Buchanan (1958).

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will pressure central banks to resort to monetary financing of budget deficits, ending the institutional separation between
fiscal and monetary policy and central bank independence.
In an open economy, budget deficits are also funded from abroad which increases both foreign and public debt.
Servicing this debt implies a drain on national income as interest paid abroad has to be subtracted from net national
product to derive net national income. In addition, to the extent that foreign lenders react negatively to economies with
rising public debt, an interest risk premium arises. This raises domestic interest rates further, increases the sum of interest
paid abroad and exacerbates investment crowding out.
Moreover, to the extent the foreign capital inflow funding budget deficits appreciates the borrower country’s real
exchange rate, there is a loss of international competitiveness and crowding out of net exports which could also stymie
economic growth. On the other hand, public investment in the form of productive public infrastructure such as roads,
bridges highways, dams, digital technology investment augments the nation’s capital stock. This can positively influence
economic growth, as does debt-funded government spending on education and health that improves workers’ human
capital.
In other words, whether debt positively or negatively affects long run growth depends on what public debt is incurred
for. If public debt reflects funding of productive public investment in infrastructure and human capital, it can enhance
economic growth. Alternatively, if it funds unproductive government spending, it is likely to lessen growth due to higher
than otherwise interest rates and exchange rates that cause private investment and net export crowding out, as well
as negative confidence and heightened uncertainty effects. In the case of the worldwide CVC fiscal response, increased
government spending was overwhelmingly unproductive in this sense.

5.2. Empirical evidence

How productive the incurrence of public debt has been is ultimately an empirical question and it turns out that the
available evidence to date is not positive for public debt. For instance, several studies for a range of countries show that a
10% increase in public debt is associated with a decrease in economic growth by around 0.3 percent.13 This negative effect
suggests public debt has not, on balance and in the longer term, been funding additional productive economic activity.
The phenomenon of compounding suggests potential national income loss into the future is therefore significant.
Australia, for instance, is projected to experience more than a 20 percent rise in its federal public debt to GDP ratio
between 2018–19 and 2023–24 due to a series of large pandemic-related fiscal deficits.14 Hence, assuming a generational
period is 20 years, a 0.6 percent economic growth loss per annum results in the future generation being over 10 percent
worse off per capita.15
Furthermore, this ignores the quite realistic possibility that rising public debt levels lead to creditworthiness down-
grades and rising interest risk premia. To the extent these raise an economy’s domestic interest rates and reduce private
investment, they would worsen national income loss even further.

6. Conclusion

Governments and central banks worldwide implemented wide ranging fiscal and liquidity support measures to counter
the economic impact of the CVC. This manifested as massive doses of liquidity, hiked government spending, tax relief and
transfers to ameliorate the sudden economic coma which the authorities imposed on their nation’s economies. Supply
side measures to support business and employment were thereby made necessary, especially a loosening of monetary
policy and emergency credit support for business.
Moreover, wage subsidy programs implemented in Australia, the United States, the United Kingdom, New Zealand and
Singapore aimed at sustaining business and employment readiness were also supply-side oriented and have proven to be
an innovative, albeit extremely costly, instrument in the fiscal armory. There is also the risk that this support may simply
delay the inevitable re-deployment of labor away from unviable firms at the expense of current and future taxpayers.
The side-effects of the fiscal policy response to the CVC are huge budget deficits around the world and substantially
increased, already-high, public debt levels. These heightened public debt levels will threaten nations’ creditworthiness,
put upward pressure on borrowing rates and threaten an outbreak of unstoppable inflationary pressure going forward.
Government debt will continue to escalate in the absence of substantial budget repair. Since the GFC the worldwide rise
in public debt has contributed significantly to the surge in total debt. The higher public debt adds to uncertainty and
means retaining at current levels, or regrettably even increasing, income and company taxes, which will stymy future
investment and productivity.
To ensure the negative effect of heightened public debt on economic growth does not worsen in the future, prudent
debt management is urgently required. Governments which have had to continue borrowing need to ensure additional

13 See for instance Afonso and Jalles (2013), Égert (2015), Gunarsa et al. (2020), Makin (2019), Kumar and Woo (2015) and Fincke and Greiner
(2015).
14 See Australian Government Publishing Service, Budget Paper No 1 2020–21, Canberra, 2020, p11–15.
15 More precisely, if per capita income growth would have been 2% per annum pre-CVC, per capita income from an index base of 100 yields 149
after compounding at 2% for 20 years. In comparison, compounding at 1.4%, reflecting the 0.6% loss from a 20% debt/GDP rise, yields 132, 11% less
than 149.

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public debt is matched by high quality public spending to augment either or both of the nation’s physical and/or human
capital base. Meanwhile, scope exists for strengthening budgetary institutions and practices to minimize fiscal risk.
Raising tax revenue is an option that governments will need to address urgently post-crisis to narrow their gaping
budget deficits and to curb the associated escalation in public debt levels. Tax reform, a perennial fiscal issue, has
consequently become more relevant than ever in the wake of the fiscal challenges arising from the CVC.
Tax systems in most market-based economies have important effects on economic efficiency and perceived fairness.
Economic efficiency is fundamental because it underpins the scope for improving welfare for the greatest number of
people. Fairness is a concept that can be difficult to define with precision, but obviously needs to be taken into account
in implementing comprehensive and successful tax reform.
Continuing to ramp up ‘stimulus’ elements in any future fiscal packages to encourage aggregate spending runs the risk
of severely hampering future economic performance, as happened post GFC. A ‘‘whatever it takes’’ fiscal mindset easily
translates to ‘‘spend like there’s no tomorrow’’. But experience tells us there is always a future macroeconomic cost when
there is a rush of budget red ink to policymakers’ heads.
This paper has argued that fiscal relief measures adopted by government around the world directed at economies’
supply sides were superior to fiscal stimulus measures aimed at stoking aggregate demand. These fiscal relief measures
were appropriate to address short term unemployment. However, just how beneficial they will prove to be in the long
term in light of the associated run up in public debt remains to be seen and suggests itself as a useful topic for future
research.

Declaration of competing interest

The authors declare that they have no known competing financial interests or personal relationships that could have
appeared to influence the work reported in this paper.

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