IFF Co-chair, Former Prime Minister, Republic of Korea President 56th Session of the UN General Assembly

When the global financial crisis (GFC) of 2008 hit, the recession was much larger than expected. As extraordinary times often call for extraordinary measures, policymakers had to think “outside the box”.

Immediately after GFC, policy makers of the advanced economies, mostly through coordinated efforts through G20, managed to launch coordinated large fiscal stimulus along with unconventional monetary policies, such as quantitative easing and negative interest rates policies. These bold policy moves helped avoid a meltdown of the global economy.

However, they led to some unintended consequences, which provide interesting lessons for us to deal with the future problems. there are four key lessons we leant from the Global Financial Crisis.

First, we learned that maintaining social cohesion is essential for the success of economic adjustment programs. As we all know, the recession associated with the GFC was much deeper and the subsequent recovery was slower than anticipated. The severity of the shock and the slow recovery contributed to rising inequality and social tensions globally. As the gap between productivity and wage widened, the labor share continued to decline in the aftermath of the GFC, The young generation was hit harder with youth unemployment rates rising much faster than that of the rest of the working age population.

With slower-than-expected recovery and rising inequality, populist movements, including Brexit, migrant crisis, and trade tensions, to name a few, emerged. As a result, maintaining social cohesion has become a critical element for the eventual success ot reform programs. We are now very aware that the poorest and most vulnerable groups need to be protected against the short-term impact of fiscal consolidation or structural reforms. Indeed, a fiscal adjustment or reform measure that is perceived as being fundamentally unfair is difficult to maintain.

Second, we learned that understanding macro-financial linkages is important. A key gap in our knowledge before the GFC was the lack of understanding of the nexus between macroeconomic and financial linkages. Before the GFC, policymakers usually focused on the inflation gap when measuring the output gap, with little attention to the financial cycle. This approach failed to capture the unsustainable output gaps in advanced economies before the GFC. Outputs gaps would have been much larger if information on the financial cycle were incorporated.

Following the GFC, policymakers have been paying much more attention to macro-financial linkages. However, this has unveiled tradeoffs for monetary policy, particularly when real and financial cycles diverge. For example, for countries with excessive credit growth and positive credit gaps as well as slow economy captured by negative output gaps, easing monetary policy to close the output gap that could lead to a further buildup of financial stability risks and fragilize the financial system.

Third, we learned the need to better assess the available fiscal space and understand the role of fiscal policy. Unlike before the GFC, fiscal policy is now considered as an effective countercyclical policy tooi, in complement to monetary policy. The global fiscal stimulus was indeed needed during the GFC, Historically low real interest rate and the debate on the possibility of secular stagnation also pushed us to question whether debt-to-GDP ratio should be the single most important determinant of medium term debt sustainability. Policymakers started to wonder whether a government can raise spending or lower taxes without endangering market access and debt sustainability. In this context, they considered various aspects of fiscal sustainability such as gross financing needs, share of local currency borrowing, debt maturities, interest rate-growth differentials, etc.

Based on this new approach that takes a broader view at fiscal sustainability, growth-enhancing stimulus, especially in the form of targeted investments that expand aggregate supply, may be desirable in many contexts. There may also be larger benefits to undertaking coordinated fiscal action across countries.

But we have to remember also that fiscal expansion is not a panacea and its impact at the time of crisis depends heavily on the existence of fiscal space, i.e. the importance of maintaining sound fiscal policies and building buffers in normal times. This is because monetary and fiscal policy can be used more aggressively when policy space is ample. Hence, financial distress tends to be less persistent when there is policy space. These findings imply that fiscal space should be built in normal times and used aggressively during periods of acute financial distress.

The last, but not the least, we learned the critical role of structural reforms. No one argues against the importance of structural reforms in boosting growth and jobs in the long run. However, recent studies, including the one by the IMF founds that the effectiveness of structural reforms in the short run varies by types of structural reforms and the timing of implementation in business cycles.

In general, product market reforms such as enhancing competition generally support growth in the short term, and this effect does not depend markedly on the overall economic condition or the business cycle. In contrast, the impact of labor market reforms depends on the overall economic condition. For example, reducing excessive unemployment benefit and easing employment protection such as more flexibility in hiring and firing of workers would support growth in good times, but can weaken aggregate demand and hurt growth in bad times. On the other hands, increased public spending on active labor market policies such as training has larger growth effects under weak macroeconomic conditions, in part because they usually entail some degree of fiscal stimulus.

What then are the implications of these lessons looking ahead?

After almost a decade of subdued growth, the global economy finally showed long waited and broad-based recovery since last year and activity has gained further momentum until early this year. There are signs, however, that the synchronized global recovery is starting to fade, and risks to global economic outlook are now tilted to the downside, reflecting increased financial market volatility, rising trade tensions, and higher oil prices.

Policymakers should take actions to raise both medium-term growth and resilience to negative shocks. Multilateral cooperation remains vital to preserve the expansion and to avoid a zero-sum game or lose-lose equilibria. Policymakers should embrace comprehensive policies to sustain growth while strengthening fiscal buffers. Structural and fiscal reforms should continue as these can boost productivity, resilience, and equity.