Like it or Not, Fiscal Policy Appears to Be Easing Across Much of the World

The Canadian general election result earlier this month surprised the pundits.  Two weeks ahead of voters casting their ballots, the three leading parties, the ruling Conservatives, the left-wing National Democratic Party and the Liberals had been running neck-and-neck in opinion polls, as they had been for the previous three months.  But then Mr Trudeau’s Liberals pulled ahead of the others and on election-day secured an eight percentage point lead over the Conservatives, who took second place.  This result was widely interpreted as voters’ rejection of the austerity policies that the Conservative government had pursued, in favour of the Liberals’ more expansive public spending programme.  Within days of Canada’s election, Poland’s voters turned out of office the PO government and installed the PiS party which, like Canada’s Liberals, advocated a more expansive fiscal policy than the erstwhile incumbents.  This began to look like a trend, a democratic turn away from fiscal restraint towards growth-oriented budgetary stances.  It seemed to tie in with the G20’s recognition that the scope that remains for monetary policy to boost demand in the economy is now limited.  Voters, too, seemed to believe that other approaches, including targeted fiscal measures, would be needed to spur economic expansion.

Even so, that might have been too hasty a conclusion.  There are no strong grounds for supposing fiscal policies were uppermost in voters’ minds when they cast their ballots in either Canada or Poland.  In Canada, centre-left parties had enjoyed consistently stronger support than the Conservatives for years past.  What changed two weeks ago was that this support began to coalesce around the Liberals, to the detriment of the NDP.  In fact, the Conservative share of the vote at the election was what opinion polls had all along indicated it would be.  So there was no sudden turn against the Conservative government’s policies but rather a fortuitous shift in the electoral arithmetic in favour of Mr Trudeau. Then again, in Poland, the relative unpopularity of PO seemed to reflect, in large part, voters’ concerns about corruption scandals.  Furthermore, in both countries the ruling party had been in office for a long time, in Canada almost ten years and in Poland eight years.  There is nothing unusual in an electorate looking for a change after such long tenure.  Such a change may say little about voters’ views regarding specific strands in the victorious party’s manifesto.

There was an instance, to be sure, earlier this year, where a national electorate’s rejection of austerity was unmistakeable.  That was the Greek general election in January.  In the event, the democratic will, expressed in that vote, seems to have made little difference to the course of policy.  Mr Tsipras, one-time champion of fiscal relaxation, is now committed to implementing budget measures tougher than those envisaged at the start of this year. Greece, it may be argued, is a special case.  However, it remains to be seen how far any finance minister will feel able to deviate from a fiscal consensus supporting austerity, when it comes to taking practical steps.  Such a minister could expect to face criticism from the credit rating agencies and an adverse judgment in financial markets.  The only example in recent years of a country where the government has followed an unorthodox fiscal policy, and that not particularly expansive, has been Hungary.  Yet Hungarian ministers have had to brave international obloquy over several years to carry through their policies.  Not many political leaders would be as thick-skinned.

political leaders are beginning to doubt the efficacy of the dominant approach to economic management

Admittedly, some political leaders are beginning to doubt the efficacy of the dominant approach to economic management in the advanced nations over the past few years.  Earlier this week, Mr Aso, Japan’s finance minister, said he did not believe that monetary policy alone could boost inflation to the Bank of Japan’s 2% targeted rate.  Within LDP policy-making circles, there is substantial support for a proposal to exempt food items from the two percentage point increase in sales tax planned for 2017.  Action along these lines would subordinate the goal of fiscal retrenchment to the pressing need to boost the real disposable incomes of Japanese consumers.  Even so, S&P last month cut its rating on Japan’s sovereign debt from AA- to A+ and followed up this week with a warning that the Japanese government needed to stick to its objective of achieving a primary budget surplus by the 2020 fiscal year.  Elsewhere, Mr Schaeuble has expressed scepticism about the effectiveness of ECB policy on its own in achieving the central bank’s inflation target.  He is far from suggesting, however, that Germany is about to adopt a more expansive fiscal stance.  On the contrary, despite the additional costs to German federal and state finances from the influx of refugees, he is still aiming for budget balance in 2016.

There are distinguished economists of a neo-Keynesian bent who argue in favour of greater fiscal flexibility but theirs is not the standard view.  There are two distinct forms that flexibility could take.  Governments could simply spend more and tax less in the hope of priming a rise in economic demand.  Those who present this policy-prescription do not usually take account of the quantity of existing government debt.  Yet, in any practical situation, it seems more than likely that the size of the government debt will be an important factor determining the impact on the economy of the debt increase resulting from looser fiscal policy.  Fiscal measures that might be expected to have an expansive effect when the stock of government debt is small could well lose their efficacy when the debt stock is larger.  The larger the debt stock, the more consumers might anticipate future fiscal tightening by increasing their saving.  Their higher saving would then offset the positive effect on spending of the increase in their disposable incomes stemming from the government’s easier fiscal stance.  The policy of fiscal ease, thus, would become self-defeating.  Since most governments in the advanced nations have, in fact, run their debt stocks up to relatively high levels, recommendations for fiscal action to support the economy more commonly take the form of proposals to re-jig government spending to reduce waste and raise spending on infrastructure, while leaving broad fiscal aggregates on unchanged tracks.

A range of studies has revealed a drop in public spending on infrastructure in recent years that bodes ill for future productive potential.  This strengthens the case for governments to step up their spending in this sector of the economy.  However, if, for the sake of fiscal stability, finance ministers have to find balancing budget cuts in other public spending programmes, the practical difficulties that might attend this strategy should be evident.  A political cost would attach to cutting almost any spending programme a government has already established.  The chances are, then, that what started out as a plan to switch government spending to infrastructure investment from other areas of expenditure would end as an upward drift in overall outlays and an ever-rising government deficit.

voters seem to be more relaxed than policymakers about the current state of the economyAt the time of the 2008-09 financial crisis, governments missed the opportunity to make the switch to infrastructure spending.  Then, voters were fearful of what the future would hold for the economy.  They might have been more than usually supportive of policies aimed at strengthening longer-term prospects for growth, even at the cost of short-term economic pain.  Now, voters seem to be more relaxed than policymakers about the current state of the economy: the sense of emergency has been dispelled.  As a result, voters’ tolerance of cuts to spending programmes that benefit them is likely to be much lower than it was seven years ago.  Back then, policymakers saw a clinching argument against raising infrastructure spending in the long lead times characteristic of such programmes.  They were looking for quick fixes.  Their priority seemed to be to restore a semblance of pre-2007 normality as soon as they could, using any fiscal leeway available to them to inject immediate demand.  The leeway was soon used up.  But because a once-off fiscal boost in no way addressed the structural problems that the advanced economies faced, any impetus to economic growth was soon spent.  If, instead, governments had adopted strategies focusing on increased infrastructure spending, the associated pick-up in spending would have been felt by now, even given the lags in the investment process.  Further, confidence in the capacity of the advanced economies to compete in global markets and to expand would have been stronger. This might have encouraged more private investment in these economies, giving additional support to growth.  The advanced economies are paying a high price for their leaders’ reluctance to recognise in 2008 that a page had turned and there was no going back to pre-2007 economic conditions.

It is now too late for the Chancellor to expect easy acceptance of the sacrifices that his strategy will demandThis is the background to Mr Osborne’s present embarrassment.  He has identified, correctly, that the UK’s infrastructure spending needs to be massively expanded and that higher government expenditure will likely be needed to set the ball rolling.  At the same time, he is well aware that the steeply rising trajectory of UK government debt since 2008 cannot be sustained indefinitely.  Consequently, he needs to find savings in other government spending programmes, not only to reverse the rising trend in the government debt/GDP ratio but also to make room for much more infrastructure spending.  But the crisis of 2008-09 is, as far as voters are concerned, long past.  It is now too late for the Chancellor to expect easy acceptance of the sacrifices that his strategy will demand.  The latest controversy over tax credits is likely to be merely the first round in a long-running fight to implement a reorientation of public spending within the overall constraints of budget responsibility.

Mr Osborne may find some consolation in budget data so far in this financial year that suggest there may be slightly more room to harmonise his various objectives than seemed likely at the time of the March Budget.  The Office for Budget Responsibility’s economic forecasts at that time are turning out to be not so wide of the mark.  However, the ratio of tax receipts to GDP has been a shade higher than was then assumed.  This ratio is very hard to predict.  It may depend, among other factors, on how many accumulated tax losses taxpayers have available to set against their tax bills.  Because of the uncertainty regarding the future tax ratio, any medium-term projection of the budget balance must be highly provisional.  Even so, it would be reasonable for the OBR to take account of a slightly higher than expected tax ratio when the Chancellor presents his Autumn Statement on 25 November. This could provide some scope for him to modify the schedule for reducing tax credits so as to reduce the financial burden on recipients, should he so choose.

There is not, as yet, a final resolution of Congressional wrangling over legislation to raise the US federal debt ceiling.  Sen. Paul has indicated he will try to filibuster the measure to give time for opposition to it to mobilise.  He followed a similar strategy, without much success, when an increase in the debt limit had been up for consideration in 2011. The latest proposal is to suspend the $18.1trn limit on federal debt until April 2017 while, at the same time, allowing $80bn of additional federal spending in fiscal years 2016 and 2017, split equally between defence and non-defence programmes.  There would be offsets to this extra spending, largely from sales of public assets, but it is not clear how much they would raise.  It is worth noting that, before the crisis in 2007, the debt ceiling had stood at only $9.0trn.  The US federal government’s indebtedness has doubled in the course of eight years.  This does not necessarily mean Congress and the Administration have been acting in bad faith by setting loose fiscal policies while extolling the virtues of budgetary restraint.  But it certainly demonstrates they are up against forces that, in a very few years, could seriously destabilise the dollar financial system.

There is not, as yet, a final resolution of Congressional wrangling over legislation to raise the US federal debt ceiling.  Sen. Paul has indicated he will try to filibuster the measure to give time for opposition to it to mobilise.  He followed a similar strategy, without much success, when an increase in the debt limit had been up for consideration in 2011. The latest proposal is to suspend the $18.1trn limit on federal debt until April 2017 while, at the same time, allowing $80bn of additional federal spending in fiscal years 2016 and 2017, split equally between defence and non-defence programmes.  There would be offsets to this extra spending, largely from sales of public assets, but it is not clear how much they would raise.  It is worth noting that, before the crisis in 2007, the debt ceiling had stood at only $9.0trn.  The US federal government’s indebtedness has doubled in the course of eight years.  This does not necessarily mean Congress and the Administration have been acting in bad faith by setting loose fiscal policies while extolling the virtues of budgetary restraint.  But it certainly demonstrates they are up against forces that, in a very few years, could seriously destabilise the dollar financial system.

More about the author

About the author

Stephen’s career spanning five decades has made him one of the most respected and unique voices in the City of London. Disclaimer regularly publishes a selection of his elegant and thoughtful essays on the global economy, which he has been writing regularly since he founded Fifth Horseman Publications in the late 1980s. As well as an economist, Stephen serves as Treasurer of the Forum for European Philosophy and was elected to the Royal Institute of Philosophy.

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