Global outlook c h a p t e r 1

Policy challenges
Challenges in advanced economies

In the immediate term, strengthened infection control 
policies in advanced economies, including effective 
surveillance and universal masking, have the 
potential to significantly alter the pandemic’s course 
and bolster the recovery. As the crisis abates, policy 
makers will need to keep policy support in place to 
sustain the recovery, despite the sharp rise in debt 
levels, gradually shifting from income support toward 
growth-enhancing policies. With limited scope for 
further central bank support, policy makers will also 
need to consider a greater role for fiscal policy in 
bolstering activity. In the long run, structural reforms 
are needed to reverse economic scarring from the 
pandemic and stimulate productivity growth, 
including by facilitating sectoral reallocation, 
harnessing digital technologies, and tackling rising 
inequality. 
Monetary and financial policies
The COVID-19 pandemic will likely contribute 
to the trend decline in real interest rates (Jordà, 
Singh, and Taylor 2020). Nominal short rates will 
likely remain near zero for years, leading to an 
extended period of markedly negative real interest 
rates as central banks shift from crisis management 
to supporting the recovery (figure 1.18.A; 
Henneberg and Mann 2020).
Given the growing reliance on unconventional 
policy tools, some major central banks have 
considered alternative policy regimes. For 
instance, the U.S. Federal Reserve has adopted 
average inflation targeting, under which inflation 
will be allowed to rise above target to compensate 
for the undershooting during downturns (Powell 
2020). The anticipation of the new approach has 
contributed to a modest rise in market-based 
inflation expectations (figure 1.18.B).
Due to the severe adverse impact of COVID-19 
on aggregate demand, inflation risks are squarely 
to the downside in the near term. That said, a 
sizable part of the pandemic’s macroeconomic 
impact was in the form of a supply shock (Brinca, 
Duarte, and Faria e Castro 2020). If policy efforts 
are unable to reverse supply-side damage, inflation 
may resume at a faster than expected pace in the 
medium-term, prompting unexpected policy 
tightening.
Financial authorities have generally responded to 
COVID-19 by using the flexibility of regulatory 
standards, 
supporting 
affected 
borrowers, 
promoting balance sheet transparency, and 
maintaining operational and business continuity 
of banks. These measures have helped to maintain 
the flow of credit and mitigated financial sector 
stress (Nier and Olafsson 2020; IMF and World 
Bank 2020). Once the pandemic is effectively 
contained, these measures would need to be 
gradually tightened or reversed to guard against a