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Post COVID-19 Exit Strategies and Emerging Markets Economic Challenges

Author

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  • Joshua Aizenman
  • Hiro Ito
Abstract
We outline two divergent exit strategies of the U.S. from the post COVID-19 debt-overhang, and analyze their implications on Emerging Markets and global stability. The first strategy is the U.S. aiming at returning to the 2019, pre-COVID mode of loose fiscal policy and accommodating monetary policy. The short-term benefits of this strategy include faster economic growth as long as the snowball effect – the difference between the interest rate on public debt and the growth rate – is negative. This strategy may entail a growing tail risk of a deeper crisis triggered by a future reversal of the snowball effect, inducing a deeper future sudden stop crises and instability of Emerging Markets. We illustrate this scenario by evaluating Emerging Markets’ lost growth decade during the 1980s, triggered by the massive reversal of the snowball effect in the U.S. during 1974-1984. The second strategy entails a two-pronged approach. First, turning U.S. fiscal priorities from fighting COVID’s medical and economic challenges, towards investment in social, medical and physical infrastructures. Second, with a lag, promoting a gradual fiscal adjustment aiming at reaching overtime primary-surpluses and debt resilience. We illustrate this scenario by reviewing the exit strategy of the U.S. post-WWII, and its repercussions on the ‘Phoenix Emergence’ of Western Europe and Japan from WWII destruction. The contrast between the two exit strategies suggests that the two-pronged approach is akin to an upfront investment in greater long-term global stability. We also empirically show how lowering the cost of serving public debt has been associated with higher real output growth.

Suggested Citation

  • Joshua Aizenman & Hiro Ito, 2020. "Post COVID-19 Exit Strategies and Emerging Markets Economic Challenges," NBER Working Papers 27966, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:27966
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    Cited by:

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    2. M. P. Afanas’ev & N. N. Shash, 2021. "From Surplus to Deficit Fiscal Policy," Studies on Russian Economic Development, Springer, vol. 32(5), pages 476-484, September.
    3. Umar, Zaghum & Manel, Youssef & Riaz, Yasir & Gubareva, Mariya, 2021. "Return and volatility transmission between emerging markets and US debt throughout the pandemic crisis," Pacific-Basin Finance Journal, Elsevier, vol. 67(C).
    4. Oussama Abi Younes & Sumru Altug, 2021. "The COVID-19 Shock: A Bayesian Approach," JRFM, MDPI, vol. 14(10), pages 1-15, October.

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    More about this item

    JEL classification:

    • F3 - International Economics - - International Finance
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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