Letters & Opinion

The Return of Fiscal Policy

Clement Wulf-Soulage
By Clement Wulf-Soulage

THERE was a time long before the financial crisis of 2008 when central bank governors were treated like rock stars – and in some instances they had almost attained the status of kings and emperors. That was the time when powerful central bank maestros like Alan Greenspan (U.S), Mervyn King (U.K) and Jean-Claude Trichet (ECB) were able to move markets skilfully and even overpower governments with their bold monetary initiatives, particularly their frequent interventions through interest rate policy, quantitatively easing (QE) and forward guidance.

Then, it seemed fiscal policy played less of a role in macro-economics as financial markets, investors and even governments were more receptive to the role monetary policy played in boosting growth and fighting inflation – at a time when monetary authorities were driven to adopt increasingly unconventional monetary policies.

Now it seems central banks have run out of ammunition, and macroeconomic policy has become the subject of a sort of “progressive economic rethinking”, whereby governments increasingly use taxation and spending to revive their economic and political fortunes, even as they maintain the rhetoric of austerity. Yet, it was always abundantly clear that monetary policy alone cannot (and couldn’t) lead to balanced growth with the attendant effects of job creation and economic confidence.

Following the stock market crash in 1987, Alan Greenspan (when he spoke the world trembled) made it clear that the Federal Reserve (the Fed) was willing and ready “to serve as a source of liquidity to support the economic and financial system”. In the decades that followed, not only was the Fed a source of liquidity as Greenspan had proclaimed, but it also served as the principal economic influencer and instigator in the effort to stimulate the American economy and get it back on a growth trajectory.

Despite presiding over one of the most prosperous periods in American history, Greenspan will be remembered as the powerful central banker who in 2001 began a series of interest rate cuts that made it easier and cheaper to borrow money (the so-called easy money policies), which allegedly lead to the dotcom bubble and the sub-prime mortgage crisis.

As I was saying, since the global financial crisis, monetary policy – based on several economic measures and indicators – appears to be rather constrained in boosting investment, employment and growth. This most likely explains why governments today are putting more faith in expansionary fiscal measures to boost public investment and bolster sagging economic growth.

With just a few months in office, the government of Theresa May in the U.K has already signalled the need for a “fiscal reset” to protect growth by pushing back a target to run a budget surplus by 2020 – and loosening the austerity grip of her predecessor on the public purse. In the next few weeks, she is expected to give a statement on her intention to ease fiscal policy to wean the economy off its dependence on low interest rates and quantitative easing. “A change is going to come and we are going to deliver it,” the prime minister said. The previous Chancellor George Osborne believed the Bank of England should bear “the responsibility for generating sufficient demand in the economy via its control over interest rates and quantitative easing (QE).”

In Canada, Prime Minister Justin Trudeau’s new government has announced plans to manage aggregate demand and boost public investment, amid historically low interest rates. “Our plan is reasonable and affordable,” Finance Minister Bill Morneau said in his first budget speech which primarily focused on new and creative spending measures. “Today, we are seizing the opportunity to invest in people and the economy, and to prepare Canada for a brighter future”, he stated.

Mr Trudeau’s fiscal plans envisage running deficits totalling almost C$120 billion ($91.7 billion) over six years – offering much needed stimulus and relief to Canada’s floundering economy.

In Japan, Abenomics is back in trend where Prime Minister Schinzo Abe has unveiled a bold plan to revive the economy with a $273 billion package – much to the delight of global markets and investors – that will offer hope to a country that has experienced six recessions since 1999 (a period dubbed the Lost Decade) characterized by entrenched deflation, soaring debt and underlying thorny structural and demographic problems. Even as Prime Minister Abe is cautiously optimistic about the prospects of his fiscal measures despite strident political opposition, he has decided to postpone a risky consumption tax hike planned for next year.

In Germany, it’s only a question of time before Angela Merkel’s government ends its ideological attachment to thrift and does more to boost domestic demand and consumption – particularly since the ECB’s policy of negative interest rates may have already run its course (German savers decry the ECB’s policy of negative interest rates). The German government has consistently complained that negative rates are “hurting its fragmented and cash-saturated banking system disproportionately, raising the prospect that hundreds of smaller banks, primarily small savings banks, could become unviable”. Currently, there is much consensus among global economists that the German government should better use the fiscal space the European Central Bank (ECB) has helped create instead of bashing the monetary institution for its ultra-loose monetary policy and its corporate bond-buying plans (ECB-bashing has become fashionable in Germany).

Back in February, a communique from G20 finance ministers and central bank governors called for more aggressive growth-oriented policies in the face of rising unemployment, ineffective austerity measures and financial instability. Apparently that clarion call was heeded as current economic data suggests that fiscal policy has made a comeback despite the fact that central banks still drive bond markets.

According to the Council on Foreign Relations’ Global Economics Monthly: “A careful look at the data shows a shift across the G20 countries toward larger fiscal deficits – and in a few cases, toward a more expansionary spending policy. Japan, China, the periphery of Europe, and some emerging markets all display this shift. Even in the United States, the fiscal squeeze of recent years has begun to ease.”

In the case of the U.S, whoever wins in November will likely favour fiscal policy to improve the country’s infrastructure and loosen limits on civilian spending.

By all indications, it seems fiscal policy in the last decade has been constrained by huge budget deficits and the rising stock of public debt (unfortunately debt is still unsustainably high is CARICOM and Latin American economies, providing less room for large fiscal policy maneuver). With painful austerity failing to achieve any meaningful outcome in some countries and creating more fiscal space (through falling deficits and debts) in others, it seems the global economy (particularly the G20 nations) is poised to benefit from greater fiscal stimulus in the coming years.

For comments, write to ClementSoulage@hotmail.de – Clement Wulf-Soulage is a Management Economist, Published Author and Former University Lecturer.

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