Next Stop Fiscal Stimulus?

Without doubt, the policy space for the global central banks is shrinking. Interest rates can probably be cut further and asset purchases can be increased, but increasingly negative side effects will frustrate the stimulatory impact of further monetary easing. In part prompted by electoral promises, hopes are rising that fiscal authorities will pick up the baton. In my view, however, there is unlikely to be major fiscal support to growth unless there is a precipitous slowdown.

There are two main reasons for this. First, over the past 18 months fiscal policies have already turned from being a meaningful headwind to growth into a small tailwind. The most recent addition to this trend was the Japanese government’s decision to postpone its planned sales tax increase to 2019. Second, policy initiatives during the global financial crisis have left most economies with very limited fiscal space. Confronted with an outlook of rising social expenditures from retiring baby boomers, many governments have decided to take a conservative approach to fiscal policy. As U.S. economists Carmen Reinhart and Kenneth Rogoff have shown, when debt levels are high, fiscal authorities tend to focus on debt reduction rather than growth support. In Japan, the government aims to raise the primary balance to zero by 2020. This requires additional fiscal tightening, not expansion.

Clearly, in tandem with disappointing growth outcomes, the commitment to the fiscal consolidation is likely to soften (as already exemplified by the delay in the sales tax increase). In Europe, the European Commission is still demanding plans for fiscal consolidation from the economies that are under the excessive deficit procedure. Granted, Spain and Portugal, despite continued violation of their fiscal targets, have been excused from financial fines. However, this has more to do with the need to support both countries through potentially turbulent election periods than an endorsement of their budget overruns; Spain and Portugal are still required to reduce their
fiscal deficits.

The likelihood of a more supportive fiscal stance is greater in the U.S., where both major presidential candidates advocate an increase in spending. Realistically, however, the timing of this spending increase is likely to be 2018, and any proposal to increase spending will probably see significant reductions as it is pushed through a split Congress.

Overall, fiscal policy remains a marginal tailwind but is unlikely to turn into a material boost for growth.

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