Friday 20/09/2019

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What’s next for fiscal policy?

Chief Economist

More expansive fiscal policy is just what the doctor would order in the current economic environment. We’ve attached a great deal of attention to this in previous writings. The big question remains whether politicians will also follow up on this advice. In this blog post, we take a look at what’s currently on the table in several important countries.

The IMF’s just published fiscal monitor provides a good starting point. A government’s fiscal stance is best measured by the change in the cyclically adjusted primary balance (i.e. the public balance minus interest payments). A positive number means that the budget is tighter, a negative number means the fiscal stance is looser. The IMF data for all advanced economies suggest that 2016 was the first year that saw fiscal easing (albeit only modestly) following years of fiscal tightening. The IMF’s forecasts, on the other hand, suggest that the overall fiscal stance will become more or less neutral in 2017 before becoming restrictive again in the next couple of years.

Source: IMF, Degroof Petercam.

That said, a look at news reports tells a different story. They suggest that there is a welcome shift taking place in national policies away from austerity towards fiscal stimulus. What is currently on the table?

United States:

US fiscal spending is expected to increase regardless of who will win the election. According to the central scenario of the Committee for a Responsible Federal Budget, Clinton will increase spending by $1.4 trillion over ten years (~ 0.72% of GDP per year) while Trump would increase it by $0.5 trillion (~0.26% of GDP per year) in the central scenario. Mrs Clinton, however, will not really engage in deficit spending as she will finance spending out of tax increases on higher earners, corporates, real estate and financial institutions ($1.25 trillion over ten years). All in all, we think Democrats will be able to compromise with Republicans at least to some degree to pass spending measures but the overall stimulus is unlikely to massively boost US economic activity.

Canada:

With a fiscal stimulus of around 1.3% of GDP in 2016, Canada has been a frontrunner in the shift to fiscal stimulus in the G7 block. The current government was elected on the specific pledge to increase government spending. This year’s and next year’s budget deficits are expected to overshoot the April budget revision. One estimate claims spending will overshoot budgets by $16 billion over the next five years (0.2% of GDP each year). Canada’s low public debt-GDP and low interest rates suggest there is plenty of fiscal space left. The upshot is that the Trudeau government’s fiscal stance will continue to be in (small) loosening mode in the years to come.

Japan:

According to the IMF October forecasts, Japan’s fiscal stance will remain expansionary in 2017 (0.2% of versus 0.3% GDP in 2016) before turning restrictive from 2018 onwards. But there is already talk of another supplementary budget for fiscal year 2016. Moreover, given the setup of the latest monetary policy decision, there are good reasons to believe that Japan will continue to implement fiscal stimulus measures and will not raise the consumption tax scheduled for October 2019 (~0.25% of GDP). All this implies that the IMF’s forecast for fiscal tightening in 2018-2020 will not materialize.

Germany:

2016 saw a significant amount of fiscal easing in Germany (around 1% of GDP) according to IMF estimates. Germany has plenty of room for further fiscal easing. The country’s ruling coalition has recently agreed to tax cuts worth €6.3 billion for 2017-18, is currently increasing spending to deal with the refugee crisis, has proposed €136 billion in new defense spending over seven years (0.6% of GDP per year), and may soon adopt a looser fiscal policy in general for infrastructure or other needs. Indeed, there is pressure from Merkel’s left, namely the SPD chair, Economics Minister and possible chancellor-candidate Sigmar Gabriel in 2017, who is pushing for around €20 billion new spending on education, infrastructure, and digital economy. Next year’s election is critical to see what will actually be implemented but there is a decent chance that Germany’s fiscal stance will be looser than what the IMF currently expects.

United Kingdom:

Prime Minister Theresa May has abandoned the pledge of a small budget surplus by 2019-20. Chancellor Philip Hammond is expected to announce new fiscal spending measures in his Nov. 23 Autumn Statement. No reliable estimates of spending increases are yet available. While Hammond has said it will not be a government spending “splurge,” it could be a positive surprise to markets. It is clear that the Tory government is planning to shift stimulus efforts away from the central bank. May is promoting a new industrial policy and increased government investment in infrastructure and other areas to boost productivity after the Brexit shock. All this means that the IMF’s forecast of fiscal tightening of around 2.5% of GDP between now and 2020 will not happen  and that we are likely to see looser fiscal policy going forward.

Italy:

Italy’s newest 2017 budget calls for a larger deficit of around 2.3% of GDP, relative to the 1.8% deficit agreed in April under the stability pact with the European Commission, which was itself a larger deficit than previously demanded by austerity hawks. The new budget includes measures to deal with refugees, earthquake repairs, pensioners, and possibly some tax amnesty. But all eyes are currently on the December constitutional referendum. Rumours claim there will be sops to buy off votes for that referendum. A no-vote could result in less fiscal tightening as the government would be significantly weakened. Even a collapse of the government cannot be excluded at this point.  

France:

According to IMF forecasts, France will adopt a fairly neutral fiscal stance in the next 2 years. The country is widely expected to fall short of deficit reduction plans which target a fiscal balance by 2021 (versus current deficit of around 3.3% of GDP). A clearer picture should emerge after the April-May presidential election and June legislative elections.  

The conclusion is that fiscal policy is moving away from austerity towards stimulus. A change in policy mentality is slowly taking place. Importantly, talk is still cheap and it’s all about effective implementation. In most cases the amount of new spending relative to GDP is fairly small. Germany remains the million-dollar question in terms of whether a game-changing policy shift will occur. Needless to say, the effect of coordinated stimulus is substantially larger than if pursued individually by countries acting alone. The cumulative effect of a real mentality and policy change across the developed world could have a meaningful positive impact on economic activity and inflation.  In any case, we think fiscal policy will prove more expansionary than what the IMF currently predicts.

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