Quarterly Outlook: The new mantra
- 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
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.
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.
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).
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.
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.
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.
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.
Christopher Dembik is head of macro analysis at Saxo Bank