Exhaustion of austerity meets maxed-out monetary policy
LONDON: There won’t be any press conferences, fireworks or tears to mark its passing, but the latest wave of austerity worldwide may well have had its day. While that may sound peculiar to Greeks still struggling to meet stiff budget targets set by creditors or even Britons faced with another round of spending cuts by finance minister George Osborne this week, a turn in post-credit crisis government retrenchment looks to be under way.
With monetary policy virtually maxed out in many parts of the world, fiscal policy is again forecast to act as a marginal net stimulant rather than a drag on world growth over the coming year. Even in the region that epitomises post-crisis government budget cuts, the euro zone, the heavy lifting looks to be over. What’s more, the so-called ‘bond vigilantes’ in the debt markets have barely blinked. Their growing ambivalence about how austerity affects debt sustainability, growth and investment amid the anaesthetic of zero interest rates, quantitative easing and a global savings glut means there’s no sign of a tantrum. Framing the shift, Edinburgh-based Standard Life Investments reckons the average country in the 34-nation Organisation for Economic Co-operation and Development will structurally loosen fiscal policy next year for the first time since 2010.
That relaxation - where ‘structural’ refers to what the fiscal balance would be if you strip out the ebb and flow of spending and taxation associated with a normal business cycle - is forecast to be just 0.2 percentage points of output.
But it’s a big moment after the eye-watering tightening of the three years through 2013 when the average OECD member structurally squeezed fiscal policy by 1.3 points per annum.
“There have been tentative signs that this ‘austerity consensus’ is breaking down,” SLI told clients, pointing to a new mood across the world on how a lack of investment is depressing the already dour world growth outlook. Economists at the firm cited changes of direction such as the infrastructure spending platform that helped the new Liberal government in Canada to power last month and Australia’s new prime minister promising to lift government investment.
Others point to last month’s US government deal loosening strict budget caps through 2017, moves that allow an additional $80 billion in spending on military and domestic programs over two years. Some cite expected new fiscal stimuli from Beijing as it pursues growth targets from China’s new five-year plan.
But the eye-catcher has been the euro zone, where spending projections have been catalysed by the conflict in Syria.
Spending plans by European governments are rising as they settle the hundreds of thousands of migrants that have streamed in since the summer and France’s outlay on defence has been boosted in response to the Nov. 13 attacks in Paris. At least seven of the 19 euro members are set to loosen budget policy next year even if European Commission forecasts show the aggregate budget deficit falling slightly. And sands are clearly shifting. Germany, Italy, Austria, Finland and Belgium included the financial impact of the refugee crisis in draft budgets for 2016 but the full cost may be far higher. French defence spending plans have already been blessed by the Commission as exceptional.
‘EXHAUSTION OF AUSTERITY’
“The idea that austerity’s not exactly the perfect recipe is gaining momentum. This is a theme across the West,” Pascal Blanque, chief investment officer at Europe’s biggest asset manager Amundi. “Since monetary policy has appproached its limits, the ball is now back in the fiscal camp.”
Pictet Asset Management’s head of multi-asset strategy Percival Stanion described it as the “exhaustion of austerity” with a clear realisation in Europe at least that enough was enough - even if large-scale stimulus is still off the table.
The public and private sector rethink of fiscal policy is driven in part by fears that the world economy could be heading for another recession with monetary policy levers at full tilt, and how central banks can’t do it all. But Deutsche Bank says its projection of an easing in 2015 of euro fiscal policy for the first time in five years hinges on QE and what has been such a sharp drop in interest payments. Together these will see public debt ratios peaking at 94.4 percent of output this year and down to 93.7 percent next.
“We imposed on central banks the need to keep economies growing without giving them an explicit mandate to do so or forcing governments to sort the rest out,” said Anne Richards, Chief Investment Officer at Aberdeen Asset Management. “We need to link fiscal and monetary policy a bit more closely.” Public policy bodies such as the OECD now urge governments to re-examine their budget spending - echoing long-standing concerns among many liberal and left-leaning economists that austerity for its own sake was self-defeating over time.
“One reason for weak potential output growth at present is weak investment growth. This has implications for the composition of fiscal packages,” the OECD said this month. “Cutting public investment... could result in higher debt ratios and harm both actual and potential output growth.”
Investors are listening. “With interest rates close to all-time lows, other governments should join Canada and shift to a more growth-friendly spending mix,” SLI said. “In the process, they might even find that the higher spending pays for itself.”