Editorial: Debts, deficits, and inflation: prescriptions for the future

The collection of articles in this symposium takes a normative and a forward-looking approach to two key macroeconomic challenges that governments across the world are facing: inflation and debt. The global COVID-19 pandemic required extensive government interventions in the economy, leading to budget deficits and growing public debt (e.g. De Jong and Ho 2021; Grossi et al., 2020; Joyce and Suryo Prabowo, 2020; Chohan, 2022). After a prolonged period of low inflation in 2010s, many countries have witnessed high inflation rates from 2020 onwards (Ha et al., 2023). Developments in debt and inflation are intimately tied to public budgeting and should hence be of high interest to budgeting scholars. In the existing budgeting literature, however, normative discussions on how to reform fiscal governance and address inflation (both at the national and subnational levels) have received less attention than should be warranted by the significance of these topics (for exceptions, see Douglas and Raudla, 2020a, b; Redburn, 2021). With this symposium, we hope to contribute to normative debates on the key macroeconomic dimensions that strongly influence public budgeting.

Two articles in the symposium – by Georgiou (2024) and Douglas and Raudla (2024) – focus on fiscal issues and discuss the challenges of deficit and debt in the European Union and US states. The two remaining articles examine the topic of inflation and its implications for fiscal policy: Nersisyan and Wray (2024) focus on the federal government level and Martell (2024) on the local government level in the USA.

The articles in this symposium offer a useful comparative perspective regarding fiscal governance by examining the USA and Europe. Although the USA is a federation and Europe a sui generis formation (combining intergovernmentalism and supranationalism in a hybrid way), they can provide lessons for each other in reconfiguring the fiscal governance architecture (see also Cottarelli and Guerguil, 2015; Hallerberg, 2014).

As Douglas and Raudla (2024) show, discussions on the architecture of fiscal rules in the US states can draw insightful lessons about the experiences of Eurozone member states. Douglas and Raudla (2024) argue that the excessive commitment to balanced budget rules in the US states has problematic consequences for the economy and the provision of public services. In adhering to balanced budget rules, state governments in the USA have become more procyclical since the mid-1980s, leading to more sluggish recoveries (Bi et al., 2023). A more relaxed stance to annual deficits would allow the US states to undertake counter-cyclical fiscal action and avoid excessive volatility of spending and/or taxation. This, in turn, would contribute to faster economic recovery from recessions. The experience the European Union has had with various fiscal governance arrangements over the past decades – including escape clauses, structural budget deficit rules and fiscal councils – can offer guidance for rethinking the fiscal rules employed by the US states. Douglas and Raudla (2024) also suggest that the Federal Reserve remain open to lending directly to states during fiscal crises to ensure that states have access to affordable credit.

The US experiences with fiscal governance, in turn, can provide lessons for the EU in reforming its fiscal architecture. The US track record indicates that there are considerable macroeconomic stabilization advantages to strong federal-level fiscal action. Significant countercyclical stimulus provided by the US federal government during the Great Recession and during the global pandemic contributed to the economic recovery (Duca, 2017; Tcherneva, 2012). This is instructive for reconsidering how the EU could best support macroeconomic stabilization. The EU's supranational fiscal rules have been revised several times over the past decades since their inception in Maastricht (1992), Larch et al., (2021), Regling (2022). They were once again renegotiated in 2022–2023. In essence, however, the new rules, adopted in December 2023 do not constitute a fundamental change in EU fiscal governance, but rather revise the existing rules incrementally by providing some additional flexibility.

The article by Georgiou (2024) offers an alternative path forward in reforming the fiscal governance of the EU. He discusses how increasing the federalist elements in EU fiscal governance is crucial for the economic and political sustainability of the union. A greater central fiscal capacity of the EU would offer opportunities for absorbing asymmetric economic shocks and therefore reduce the need for pre-emptive action against negative cross-border externalities. It would also allow for swifter fiscal action by eliminating the time lag in coordinating and implementing policy responses among the member states. Georgiou (2024) suggests that this would especially be the case if the fiscal capacity were based on automatic stabilizers (income taxation and automatic spending obligations such as unemployment insurance). An abundant supply of an EU-wide safe asset (i.e. EU-issued bonds) around which to structure the EU's financial system would also avoid the need to constantly tinker with the debt and deficit rules that so far have not offered a solid structure for the EU's fiscal and economic governance. Since the pandemic, the EU has already had some experiences with creating borrowing capacity for the EU in the form of the “Temporary Support to mitigate Unemployment Risks in an Emergency” and “Next Generation EU” programs (see Fabbrini, 2022). Those measures were intended to be temporary, however, and in going forward, a permanent fiscal capacity should be designed.

Douglas and Raudla (2024) and Georgiou (2024) present somewhat different answers to the question of how permanent fiscal capacity (at the central level) and fiscal rules at the state (or member state) level relate to each other. Georgiou (2024) suggests that the creation of central fiscal capacity for the EU would reduce the need for strict fiscal rules for member states. Douglas and Raudla (2024), however, argue that despite the central fiscal capacity that is available from the federal government in the USA, there is still a need for more sophisticated fiscal rules at the state level.

In their article, Nersisyan and Wray (2024) challenge the mainstream consensus that slow economic growth is a supply-side problem while inflation is a demand-side problem. They investigate the causes of 2021–2023 inflation in the USA and assess whether raising interest rates is the correct solution. They examine the macroeconomic and microeconomics explanations for the causes of inflation. They argue that the spike in inflation has been driven by microeconomic factors (i.e. disrupted supply chains and pricing practices of corporations) rather than too much demand. The corporations took advantage of the period of disruption and increased their prices. Nersisyan and Wray (2024) suggest that since the aggregate demand stimulus offered by fiscal action by the federal government had already run its course by the time inflation surged, it would be implausible to attribute increased inflation to the fiscal stimulus (see also Nersisyan and Wray, 2022). Hence, they argue that raising interest rates has been the wrong medicine. They believe that a combination of fiscal and monetary policy tightening in the face of continuing significant supply-side problems make a hard landing more probable. Nersisyan and Wray (2024) propose that the following measures would constitute a better way for tackling inflation: more investment in low-income housing (to curtail rent hikes), higher investment in alternative energy (to reduce dependence on volatile and climate-unfriendly fossil fuels) and greater efforts to combat price-gouging activities by large corporations.

In light of the US experiences with monetary and fiscal policies, Nersisyan and Wray (2024) urge scholars to reconsider how we view inflation. The pandemic demonstrated that the key challenge in the economy is the availability (or lack thereof) of real resources. Hence, the main policy effort should be to expand real resource space. This is a goal that monetary policy cannot achieve. Fiscal policy is better able to achieve this purpose, but it is necessary to rethink how we implement it. Instead of indiscriminate stimulus spending, a more targeted approach should be used – channeling resources to parts of the economy where demand is insufficient. Furthermore, fiscal policy should be used to boost investment in those areas of the economy that help to increase real resource space in the long term (e.g. sectors that support sustainability transitions).

The article by Martell (2024) explores the post-pandemic inflationary environment of US local governments. Her study examines how inflation and high interest rates have affected local government finances: revenues, operating costs, capital costs and debt service. Martell (2024) finds that on the revenue side, the growth of property values and resulting increase in property tax revenue has played an important role in bolstering the financial situation for local governments. At the same time, inflation creates upward pressures on operating and capital costs. Furthermore, the combination of high interest rates and inflation have had negative effects on local debt issuance – by reducing credit quality and increasing interest costs, leading to contractions in municipal debt markets. Martell (2024) also takes stock of inflation management strategies employed by local governments and assesses ongoing challenges to local governments' financial health and resilience. She emphasizes that in a situation where local governments face increasing demands from their local economies (e.g. to deal with affordable housing and climate change) combined with tighter labor markets, high inflation, and interest rates; they have to act strategically, boldly and collaboratively to achieve fiscal health and financial resilience. Martell (2024) recommends the following strategies. First, local governments should bring their revenue collection schemes up to date with local economic generators. This would address the negative impacts of inflation on revenue growth and improve tax collection. Second, local governments could connect a portion of the revenues generated by new economic development to expenditures that invest in the pre-emptive amelioration of social problems (e.g. for providing more affordable housing). Third, local governments should channel intergovernmental revenue into investments that will yield long-term benefits to social equity, the community, revenue generation and infrastructure.

In light of the articles published in this symposium, budgeting scholarship should benefit from the following insights.

First, in order to better analyze budget processes, it is useful to keep in mind the larger questions that govern the macroeconomic framework in which budgeting takes place. While the main focus of budgeting research is on how budgeting works within a given macro framework, it is useful to move up on the ladder of abstraction and also explore how insights from budgeting research can inform discussions on macroeconomic governance and vice versa.

Second, the symposium points to the value of comparative perspectives in studying the relationship between macroeconomic issues and budgeting. In particular, despite considerable differences in the polities of the USA and the European Union, their varying experiences with fiscal and monetary governance offer opportunities to learn from each other in discussing how to reform fiscal governance at the central and (member) state level. The track record of the USA in macroeconomic stabilization offers support for creating a stronger central fiscal capacity in the European Union. Conversely, the US states can draw lessons from the EU fiscal governance framework in reconsidering their balanced budget rules.

Third, in examining the challenges of debt and inflation, zooming in on different government levels is crucial for a holistic analysis. The articles in our symposium offer valuable insights about how the fiscal and monetary actions at the central level affect budgeting at lower levels of government (member state, state and local government). Subnational impacts of central level policies, in turn, play a crucial role in shaping overall financial and economic effects.

Finally, fiscal and monetary policy issues are often discussed separately, and budgeting scholars in particular tend to pay more attention to the former than the latter. The symposium draws attention to the insight that in order to fully understand the context of budgeting, it is crucial to consider fiscal and monetary regimes in tandem. A monetary regime strongly conditions what kind of fiscal action is available for a polity, and fiscal policy choices, in turn, can have important implications for monetary policy.

This work was supported by the Estonian Research Council grant PRG1125.