(Dieppe 2020; Kose and Ohnsorge 2020). The additional damage from the pandemic may further steepen the slowdown in potential output growth (World Bank 2021a).

Third, interest rates may begin to rise if inflationary pressures strengthen. Longer-term structural factors have depressed inflation globally over the past five decades: robust population growth in EMDEs; rapid expansion of global value chains accompanied by trade and financial liberalization; and a broad-based switch to more resilient monetary, exchange rate, and fiscal frameworks. However, as global value chains have matured and the momentum for trade liberalization has faded, trade growth and its accompanying competitive pressures have slowed (Constantinescu, Mattoo, and Ruta 2020); global population growth is slowing (Kilic Celik, Kose, and Ohnsorge 2020); and, especially in EMDEs, the unprecedented policy stimulus, including through new instruments, during the pandemic may erode monetary and fiscal frameworks if not carefully managed (Ha and Kindberg-Hanlon 2021). If this eventually increases inflationary pressures, it could also be reflected in higher interest rates.

# **III.2. Fiscal consolidation**

Fiscal consolidation can generate primary fiscal surpluses, through expenditure cuts or revenue increases, to pay off existing debt. Over the next few years, many countries plan to implement some fiscal consolidation after the record deficits caused by the pandemic. In 2020, global primary fiscal deficits, on average, widened by 7 percentage points of GDP, to 9 percent of GDP—the steepest single-year deterioration in the past four decades. The deterioration was broad-based, affecting more than 80 percent of advanced economies and EMDEs, but particularly pronounced in advanced economies where primary deficits widened to 10 percent of GDP—considerably more than in EMDEs.

Blanchard, Felman and Subramanian (2021) argue that a new consensus on fiscal policy has emerged in advanced economies with the following three features. First, stimulus (fiscal or monetary) is warranted to support growth. Second, since monetary policy is near the zero-lower bound in most major economies, fiscal policy needs to be the tool for stimulus.<sup>9</sup> Third, sustainability concerns about fiscal stimulus are mitigated by prospects for interest rates being below growth rates.

However, regardless of the reality for advanced economies, for some EMDEs, fiscal consolidation may be an appropriate option for debt reduction. In EMDEs, greater uncertainty about prospects for growth and interest rates argues for heavy reliance on fiscal consolidation to lower debt (Blanchard, Felman, and Subramanian 2021). In addition, especially during times of financial market stress, EMDEs are more likely than advanced economies to lose market access. Loss of financial market access, or the threat thereof, may force EMDEs into severe fiscal consolidation.

> 9 The view that normal monetary policy (interest rate policy) is unavailable at the zero bound assumes away the possibility that unconstrained negative interest rate policy can be achieved either by digitizing currency or by taxing paper currency, policies considered by Rogoff (2016).

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