Fiscal Stimulus Revisited

More fiscal stimulus, please.

Photographer: Richard Baker/In Pictures/Getty Images

Budget deficits may be coming out of retirement. With economies all over the world growing too slowly and little scope left for new monetary stimulus, governments are turning their attention back to fiscal policy.

This shift in thinking is overdue. In many countries, though not all, fiscal expansion is not just possible but also necessary. A resumption of budget activism, if it happens, won't be riskless, so caution will be needed. A stubborn commitment to fiscal austerity, though, would be riskier still.

The immediate response to the 2008 crash included fiscal easing -- sometimes deliberate and sometimes the automatic consequence (higher public spending, lower tax revenues) of slumping activity. In most cases, expansionary budgets lessened the impact of collapsing demand, but they also pushed up public debt. Before long, governments started tightening their budgets to get debt back under control.

With demand still lacking, the hope was that monetary expansion would be enough to support recovery. It wasn't. Governments have found that monetary policy is losing its potency. Interest rates are close to zero in many countries, and in some even negative. Huge bond-buying programs -- so-called quantitative easing -- have delivered an additional monetary punch, but again with diminishing effects, and with a growing risk of financial instability as well.

So fiscal policy, despite the recent growth of public debt, is back on the agenda. Central banks have been leading the call. In June, Federal Reserve Chair Janet Yellen told the Senate Banking Committee that U.S. fiscal policy had "not played a supportive role." In July, the European Central Bank's chief economist, Peter Praet, said "monetary policy cannot be the only remedy to our current economic challenges."

Governments are responding. Following the U.K.'s decision to quit the European Union, the new Chancellor of the Exchequer, Philip Hammond, has promised a break with his predecessor's approach and says he will "reset" fiscal policy. Added investment in infrastructure is under consideration as part of a new industrial strategy.

Earlier this year Canadian Prime Minister Justin Trudeau announced higher public spending and an increase in projected deficits. A C$120 billion ($91 billion) six-year infrastructure program will include at least 10 rail and public-transit projects, a C$4 billion ($3.1 billion) bridge connecting Detroit and Windsor, Ontario, and some C$12 billion ($9.3 billion) of fast-starting projects including water systems and public housing.

Japan has been trying to use fiscal stimulus for years -- and has an enormous public debt to prove it. Yet its efforts have lacked force because of contradictory messaging and hesitant execution. The government is about to try again, with 4.6 trillion yen ($45 billion) of new spending in its latest 28-trillion-yen ($276 billion) stimulus package.

Even Germany, the global champion of fiscal orthodoxy, appears to be relenting. With an election approaching next year, Finance Minister Wolfgang Schaeuble recently suggested that the economy has scope for lower taxes. Shocking stuff. 

In fact, it's putting it mildly to say that Germany has room to relax its fiscal policy. It has a record-high budget surplus. Anemic second-quarter growth of just 0.3 percent in the euro zone as a whole follows years of stagnation. Tight fiscal policy in Germany worsens Europe's internal imbalances and piles pressure on the euro area's weakest economies. If any country in the world should be easing back on austerity, it's Germany.

Some fresh fiscal stimulus wouldn't go amiss in the U.S. either. Both presidential candidates are calling for a big new effort on infrastructure. Nobody who's used the country's roads or airports needs much convincing. U.S. public debt has risen sharply since 2008, and demographic trends will keep pushing it higher in the longer term -- but with long-term interest rates at their current depressed levels, borrowing for public investment has never been more affordable. If the money is spent wisely, it will spur growth, which would help to lighten the projected debt load.

And crucially, in the U.S. as elsewhere, judicious fiscal expansion would take the pressure off monetary policy, allowing central banks to stabilize their balance sheets and normalize interest rates faster than they otherwise could. 

There's no need to build bridges to nowhere, or hire armies of unemployed youth to dig and refill holes in the ground. Where opportunities for productive public investment don't present themselves, governments can cut taxes instead -- especially for the low-paid, who'll be more apt to spend the windfall and thereby boost aggregate demand. Extra public spending also needs to go hand in hand with heightened oversight, to ensure that the resources don't leak away as waste or graft. And governments do need to keep an eye on long-term fiscal sustainability, which means avoiding open-ended commitments that will permanently increase public spending.

Nonetheless, a cautious shift away from fiscal austerity is justified. With monetary policy already at or beyond its prudent limits, and economies still struggling for lack of demand, budget policy needs to step up. A time for strict fiscal discipline will come. That time isn't now.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.