Health crisis issues and economic and financial challenges have forced governments to step in with unprecedented spending. While public spending on a health crisis such as the Covid-19 pandemic is urgent and temporary, economic recovery requires investment over the longer term to boost the market and stimulate the private sector. 

Recovery funding is also needed to support education and healthcare and to develop basic and technological infrastructure. The US has already spent $1.9 trillion on its stimulus programme, and it is about to allocate more, amounting to 20 per cent of US GDP in a single year. Stimulus allocations in the EU countries average 10 per cent of GDP. Other Organisation for Economic Cooperation and Development (OECD) countries that have the means to do so are doing the same thing.

One reason why these countries have been able to mobilise such funding is because of their access to low-cost borrowing thanks to the monetary easing measures by their central banks and their good credit standing. The developing countries do not have such advantages. If they exceed certain limits, they might trigger domestic inflation, and the credit-rating agencies will warn them of unpleasant consequences such as the higher spreads.

Policy makers thus face some crucial questions, including what the recovery will look like. The answer is probably a K-shaped recovery curve that reflects the growing disparities between states and sectors in growth rates. This translates into further inequality and the potential for social and political tensions that could jeopardise economic stability.

Another question concerns the future of labour. Before the pandemic, discussion focused on the impacts of the fourth industrial revolution, digitisation and information technology on unemployment levels. But today entire and partial lockdowns on economic activities in order to contain the spread of Covid-19 have put more than 250 million people worldwide out of work, and that is only in the formal sector. 

In the informal sector, the figure is many times higher. This is where government intervention is critical, whether through economic-stimulus programmes or through policies to regulate the reopening of economic sectors and measures to promote hybrid business operations using a blend of traditional work on site and online employment.

What are the risks of resurgent inflation? In the US, after two decades in which inflation has largely been kept under control, experts are debating the inflationary impacts of Washington’s huge stimulus package. Inflation averaged 1.2 per cent in the US in 2020. In March this year, it stood at 2.6 per cent. 

Former US secretary of the treasury Larry Summers leads the camp holding that the recent stimulus package is bigger than is necessary and that it courts inflationary risks. The US Federal Reserve draws a line between some transitory inflation and a more long-lasting inflationary pressure that would require intervention. 

What directions will interest rates take? Despite the relative decline of the US share of the global economy since the turn of the century, the dollar still dominates the currency exchange markets and makes up more than 60 per cent of the currency reserves of central banks around the world and around 85 per cent of the trade on the international currency markets. Therefore, any changes in the interest rate on the dollar will still have their customary impacts on the interest rates of other major currencies and on exchange rates and cash flows, especially short-term flows.

With the growing role of government comes the need for the optimal allocation of economic resources. According to US-Italian economist Mariana Mazzucato, the more public spending is “mission-oriented,” the more its inclusive and productivity enhancing effects will support comprehensive economic growth with greater added-value in the long run. 

For example, such spending might be directed towards research and development in medicine and technology or to support efforts in fighting the impacts of climate change. However, if it is invested in ways that crowd out the private sector and restrict or distort competition in the markets, then its harms will eventually outweigh its benefits.

Any increase in public spending necessitates a review of national revenues, especially taxes. In the US, the Biden administration has moved to support increased public spending by raising the tax on corporate profits from 21 to 28 per cent and improving tax-collection processes. It is also proposing a global minimum tax rate of 21 per cent, will require international coordination for effective implementation. There are also calls for possible changes in the capital-gains tax structure in the US.

At another level, the proper conduct of economic policy today needs to take into account a new phenomenon and its impacts on the economy and monetary stability in the shape of the increasing interest in crypto-assets, such as bitcoin. 

These cryptos, which function according to complex algorithms and independently of central banks, are highly volatile and cannot be relied on as a repository of value or as broadly acceptable legal tender. However, they come with advances in digitisation and communications technology, and they benefit from the decentralisation of transactions through peer-to-peer networking and the lack of the need for a mediating entity, thereby nullifying transaction costs. They also benefit from the security of blockchain protocols and distributed data ledgers that operate without the need for centralised control. 

A central bank digital currency (CBDC) issued by a central bank could be used for payments and other transactions through electronic wallets with no need for an intermediary bank. CBDCs would benefit from the advances in blockchain technology, and they would enjoy the advantages of a currency certified as legal tender by a sovereign central bank. 

According to a recent survey undertaken by the Bank for International Settlements (BIS), 60 per cent of central banks are in the process of experimenting with CBDCs and 14 per cent have moved on to the pilot stage. Experts are watching how China’s digital Yuan currency (e-CNY) will fare when it is rolled out in several cities. 

There is still a way to go, but in the event the e-CNY is officially launched, it will be a game-changer in the international currency markets.

*An Arabic version of this article appeared on Wednesday in Asharq Al-Awsat.

*A version of this article appears in print in the 22 April, 2021 edition of Al-Ahram Weekly