Article / 30 September 2016 at 10:00 GMT

Quarterly Outlook: The new mantra

Head of Macro Analysis / Saxo Bank
  • Fiscal spending will top the agenda for investors globally in Q4
  • Economic liberalism was discredited by the global financial crisis
  • Low interest rates make fiscal stimulus projects viable
  • China and Japan are leading the way with imaginative programmes
  • Elections in Italy, Spain, Austria and France will quell appetite for austerity
  • Governments must shun old-fashioned protectionism at all costs

By Christopher Dembik

Over the past three months, several global central banks have stressed that monetary policy can only buy time but other actions are also needed. In its previous quarterly bulletin, the Bank of England strikingly demonstrated that the money multiplier, which justifies the intervention of central banks, does not work. In these circumstances, the ball is in the governments’ court. 

In a dramatic turnaround, all the international organisations, especially the International Monetary Fund and the G20, have called for more public spending to push economic growth close to its pre-crisis level. There is no doubt that this quarter, fiscal spending will top the agenda for investors all around the world.

 Printing more and more money just didn't work – politicians must now do their bit. Pic: iStock

Once in a lifetime opportunity

The context is actually very favourable for higher public spending. Economic liberalism, that has exerted an overwhelming influence on policymaking over the last thirty years, has been discredited by the emergence of the global financial crisis. There is no dominant economic ideology anymore. Moreover, the role of rating agencies, which have acted as the guardians of fiscal orthodoxy, is now much less important for investors. 

However, the real incentive to make public spending is linked to historically low borrowing rates on financial markets. Global credit conditions are close to the loosest they have ever been with the average yield on global government bonds (all maturities included) hovering around 0.9% which is well below the 10-year average of 2.30%. In some cases, the situation is even more unusual, such as in Germany where more than 80% of the sovereign bond market is carrying negative rates.

China and Japan are leading the way

In terms of fiscal stimulus, Asia is leading the way. Investment by publicly-owned companies has increased by 24% since the beginning of the year in China in a move to offset the deceleration of private investment. The aim is to avoid an abrupt downturn of the economy but it also accentuates industrial overcapacity and the deflationary spiral (which has, however, slowed down since the start of the summer due to higher global commodities prices). 

To limit the negative effects, promising measures have recently been decided including granting equal access to private investors in education and medical care, sending out inspections teams to make sure projects are carried out on the ground and investing in infrastructure in rural areas, where it is really needed. If implemented, these decisions could certainly help fix the economy.

A similar impact can be hardly expected from the stimulus package worth about 28 trillion yen (though direct spending only represents 7.5 trillion yen) that was approved last August by Japan. Compared to previous packages, it is not really impressive. It will probably lead to a temporary burst in industrial production but the effect will quickly vanish once again due to the deflationary mind-set of companies and households. There is no easy trigger to switch this mind-set. Until now, nothing has worked. A similar situation occurred in the USA in the 1930s and, actually, only war solved it.
The last Japanese fiscal package worth 28 trillion yen mostly consists of infrastructure spending and cash handouts to poor families.

Europe: The end of austerity and the 3% rule

Unlike Japan, the risk of deflation is not the main issue in Europe. Despite very weak underlying inflationary pressures, there is no change in household and corporate behaviour resulting from low inflation for a prolonged period of time. In this context, fiscal policy can still be effective.

Europe hasn’t waited for the green light of the IMF to push for fiscal stimulus. In April 2015, the Juncker plan got underway. It is on the right course since 20.4 billion euros worth of projects (one quarter of this amount for the benefit of small business and start-ups) have been approved on a three-year target of 60 billion euros by the EFSI Investment Committee. 

However, it does not fulfill its initial promises in terms of growth. Therefore, to speed up the process, more than one third of the EU countries have recently launched or plan to launch some sort of fiscal stimulus in the coming weeks (e.g. UK and Hungary). 

Yet, only three countries have sufficiently strong public finances to do so: Germany, Sweden and Austria. The elections and referendums that will take place in the coming months in Italy, Spain and Austria and in France in April 2017 will inevitably favour the spur of populism and weaken appetite for austerity (or fiscal consolidation). 

For the moment, Keynesian-style stimulus programs have not been embraced, with the exception of the UK that may opt for a strategy of infrastructure spending to overcome uncertainty in the aftermath of the Brexit vote. In most cases, the measures mostly consist in lower corporate tax to prevent delocalisation to Ireland and to stimulate investment. Britain’s vote has also been a strong near-term catalyst for fiscal cuts in many countries. However, significant tax cuts or tax credits for households, to offset the important increase that has happened over the past years and, why not, direct cash handouts to poor families like in Japan could occur more frequently close to the election date.
corporate tax


The comeback of expansionary fiscal policy put a definitive end to the 3% deficit rule. As the saying goes, promises only bind those who believe in them. Italy, whose GDP at constant prices has not increased one iota over the past 15 years, as well as Spain and Portugal are expected to miss their deficit reduction target in 2016 and 2017. In the case of France, considering the economic programme of the main presidential candidates from the right and the left, the election outcome will be, in any case, the break of the 3% deficit pledge, as happened before in the early 2000s. Due to the absence of a coordinated European fiscal policy, it is the reign of "every man for himself" that prevails.

General govt primary balances
Considering its primary surplus, Germany is the largest European country to be able to engage in fiscal stimulus. It will eventually be forced to do so to integrate the migrants it welcomed.

US government frozen by the presidential election

In this debate about public spending, the noticeable absentee is the United States. The honourable performance of the US economy and the upcoming presidential election do not militate for fiscal stimulus. However, we can easily anticipate that if Hillary Clinton wins, she would not hesitate to use the fiscal lever when signs of economic slowdown appear. She may be inspired by the Bill Clinton stimulus package of 1993 that put US growth back on the right track.
However, it is more difficult to assess the decisions that Donald Trump could take in these circumstances. His economic programme contains interesting measures, such as lowering corporate tax to 15%, but also absurd and dangerous proposals like ripping up existing trade agreements and imposing heavy taxes on imports.

Back in 1993 Bill Clinton unveiled a massive tax-cutting programme including lower taxes for 90% of small businesses. Hilary might be tempted to follow suit should she win. Pic: Wikimedia

This quarter will be the opportunity to discuss (again) the role of the state in the economy. Unfortunately, it is a debate that is systematically flawed because it is influenced by ideology whereas pragmatism should prevail. Public spending is neither bad nor good, and it is certainly not a miracle solution, as shown by the example of Japan. Its effectiveness depends on the economic diagnosis and on its implementation. However, it is quite good news that governments will finally step in and that monetary policy does not substitute for fiscal policy anymore, which has been the case since 2008.

Traditionally, the debate is about big government versus small government but this opposition does not make any sense in a globalised world where the state needs to further regulate finance and faces the challenge of climate change. We should better talk about smart government: a government that relies on new technologies to reduce operating costs, that tackles the issue of declining productivity and that develops a real industrial policy, which have never been done in the past 25 years in most of the rich countries. 

My message to governments: at all costs, stay away from old-fashioned protectionism and understand that it is a waste of money and time to support industries that are doomed to decline. Those strategies have zero chance of success.

 — Edited by Clare MacCarthy

Christopher Dembik is head of macro analysis at Saxo Bank


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