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But how will we pay for this?

What about central banks?

Central bank actions over the coming months and years will also have important implications for developed markets’ debt arithmetic. In fact, everything central banks are doing to help their economies right now increases the odds of a sustainable debt scenario going forward. Although explicit coordination between monetary and fiscal policy would violate the sacrosanct principle of central bank independence, the reality is that the massive monetary accommodations in most developed markets in response to the pandemic will help significantly from a debt perspective.

Beyond policies of zero or negative interest rates, central banks will need to adopt forward-guidance frameworks. Global financial markets no doubt will respond better if they know what’s coming. The U.S. Federal Reserve, for example, will need to put a forward-guidance framework in place as soon as the U.S. economy starts to move from contraction to expansion, which Vanguard’s base case foresees occurring in the second half of 2020. Guidance could be timeline-driven, or it could depend on data outcomes such as when unemployment falls back toward more typical levels or when inflation rises toward targets around 2% in most developed markets. (My colleague Andrew Patterson recently commented on Vanguard’s views on inflation.)

Higher inflation could be beneficial, if central banks can finally achieve it. In normal conditions, higher inflation doesn’t help with debt reduction because bond markets eventually catch up through higher interest rates. But in rare circumstances like wartime spending or disaster responses, such as in this COVID-19 crisis, higher inflation can erode the value of one-off debt.

Of course, the greatest condition of all is the pandemic’s progression. A second wave of infection that requires another round of national lockdowns is a worst-case scenario—from both health and economic standpoints—that we unfortunately can’t rule out. On the other hand, a sooner-than-expected development of a vaccine or indications that we’ve achieved herd immunity would accelerate recoveries.

I don’t mean to suggest that everything is rosy. Recovery will take time and be uneven, coming later to sectors that depend on face-to-face interaction. And while our view on developed markets is sanguine, our outlook for emerging markets—which we don’t foresee being able to simply grow themselves out of debt—is far more challenging. But considering where we’ve been in recent months, just being able to discuss recovery in present terms offers promise.

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