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Shift in Global Fiscal Gear
Kathleen Stephansen, Founder, Kathleen Stephansen Economics, New York, USThe recent G-20 meeting added 'shared growth' to the usual mantra of 'strong, sustainable and balanced growth' as a common goal, a euphemism for more fiscal policy accommodation. It is a notable and welcome shift in the public discourse from the past few years.
Why fiscal stimulus? For most of the post-Great Recession period, the burden was squarely on monetary policy. Unconventional monetary policy aimed to restore financial stability, put global growth back on trend and offset global headwinds. The Great Recession brought a permanent loss of output, low inflation and very high debt levels. And subsequent shocks such as natural disasters (earthquakes and tsunami disrupting the manufacturing supply chain), geopolitical crises (Middle East, Russia and more recently Turkey), sovereign crises and macroeconomics (decline in global trade, restrictive fiscal policies, end of the commodity super-cycle, and economic restructuring in China) have all weighed on growth. Brexit is yet another shock.
Central banks are compelled to keep their ultraaccommodative stance and their bias toward easier monetary policy, with the exception of the Fed. That is the case of the BoE, the ECB and the BoJ. With diminishing marginal return on additional credit, further credit expansion provides limited support for economic growth. Either credit needs to grow faster than GDP growth or other forms of monetary accommodation need to be introduced, such as the negative interest rate policy (NIRP). NIRP aimed at deterring capital inflows and/or encouraging lending and spending. The outcome remains uncertain: In terms of foreign exchange depreciation, NIRP represents a zero-sum game when growth is moderate at best. As for domestic demand, swapping future spending for current spending may not achieve the sought-after demand impulse in the current cycle as an ensuing loss of confidence acts as a deterrent.
Global growth has yet to re-attain the prior trend and continues to exhibit weak investment spending, weak global trade and very low inflation. It remains on a sluggish though resilient 3% trajectory, slower than both the 3.6% long-term average and the close to 4% average of the decade prior to the Great Recession.
In the US, consumer spending bounced back decidedly in Q2 after a weak Q1 performance, the labor market rebounded handsomely in June, following the weak May reading, and the housing market continues to heal. But Q2 real disposable income growth lagged well behind spending growth and business investment contracted (the third consecutive decline), suggesting headwinds to growth in future quarters.
In the Euro area, the recovery is sluggish and inflation undershoots ongoing. It is too soon to fully assess the impact of Brexit, but confidence has been hit. The German business sentiment index (the Euro area ZEW sentiment index) posted a sharp fall in July, even though the Euro area PMI remained in expansionary territory.
In the UK, both the Manufacturing and Services Purchasing Managers Indices (PMI) declined abruptly in July. Longer-term, much will depend on the political process and the trade and financial agreements reached with the EU. Negotiations can be lengthy, thereby adding to uncertainty and loss of confidence.
Japan’s recovery is equally sluggish, with the momentum softening in Q2 – the Manufacturing PMI continued to contract in July – and additional policy stimulus is in the pipeline.
Emerging market economies (EM) have seen positive developments that will mitigate the effects of longer-run challenges. Commodity prices have firmed and China’s growth remains on track (China’s July whole-economy business sentiment outperformed). That being said, EM economies continue to face long-lasting challenges that will dampen growth, notably the restructuring of the Chinese economy and the need for other large EM economies to restructure (Brazil), the sharp slowdown in global trade and high debt levels.
Against this backdrop, global central bankers, particularly ECB’s Draghi and past and current Fed Presidents, have argued that monetary policy alone cannot spearhead growth onto a stronger and sustainable growth path. Monetary policy is hitting diminishing returns and arguably contributing to asset price bubbles. As seen earlier this year, bursts of asset bubbles or sharp asset re-pricing trigger risk aversion and heightened volatility. The potential spillover effects onto the real economy make any policy exit more difficult.
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