Nouriel Roubini is chairman of Roubini Macro Associates and professor of economics at the Stern School of Business, New York University
Since the global financial crisis of 2008, monetary policy has borne much of the burden of sustaining aggregate demand, boosting growth and preventing deflation in developed economies. Fiscal policy was constrained by large budget deficits and rising stocks of public debt, with many countries implementing austerity to ensure debt sustainability. Eight years later, it’s time to pass the baton.
As the only game in town when it came to economic stimulus, central banks were driven to adopt increasingly unconventional monetary policies. They began by cutting interest rates to zero, then introduced forward guidance, committing to keep policy rates at zero for a protracted period.
In rapid succession, advanced-country central banks also launched quantitative easing, purchasing massive volumes of long-term government securities to reduce their yields. They also initiated credit easing, or purchases of private assets to reduce the costs of private-sector borrowing. Most recently, some monetary authorities have taken interest rates negative.
While these policies boosted asset prices and growth while preventing deflation, they are reaching their limits. In fact, negative policy rates may hurt banks’ profitability and willingness to extend credit. As for quantitative easing, central banks may simply run out of government bonds to buy.
Yet most economies are far from where they need to be. If below-trend growth continues, monetary policy may well lack the tools to address it, particularly if tail risks – economic, financial, political or geopolitical – also undermine recovery. If banks are driven to reduce lending to the private sector, monetary policy may become less effective, ineffective or even counterproductive.
In such a context, fiscal policy would be the only effective macroeconomic-policy tool left, and thus would have to assume much more responsibility for countering recessionary pressures. But there is no need to wait until central banks run out of ammunition. We should begin activating fiscal policy now, for several reasons.
For starters, because of painful austerity, deficits and debts have fallen, meaning that most advanced economies now have some fiscal space. Moreover, central banks’ near-zero policy rates and effective monetization of debt by way of quantitative easing would enhance the impact of fiscal policy on aggregate demand. And long-term government bond yields are at a historic low, enabling governments to spend more and reduce taxes while financing deficits cheaply.
Finally, most advanced economies need to repair or replace crumbling infrastructure, a form of investment with higher returns than government bonds, especially when bond yields are extremely low. Public infrastructure not only increases aggregate demand; it also increases aggregate supply, as it supports private-sector productivity and efficiency.
The good news is that the G7 economies seem poised to begin – or perhaps have already begun – to rely more on fiscal policy to bolster sagging growth, even as they maintain the rhetoric of austerity. In Canada, Prime Minister Justin Trudeau’s administration has announced a plan to boost public investment. And Japanese Prime Minister Shinzo Abe has decided to postpone a risky consumption-tax hike planned for next year, while also announcing supplementary budgets to increase spending and boost the household sector’s purchasing power.
The British government, led by Prime Minister Theresa May, has dropped the target of eliminating the deficit by the end of the decade. After the vote to leave the European Union, Ms. May’s government has designed expansionary fiscal policies aimed at spurring growth and improving economic conditions for cities, regions and groups left behind in the past decade.
Even in the euro zone, there is some movement. Germany will spend more on refugees, defence, security and infrastructure, while reducing taxes moderately. And, with the European Commission showing more flexibility on targets and ceilings, the rest of the euro zone may also be able to use fiscal policy more effectively. If fully implemented, the so-called Juncker Plan will boost public investment throughout the European Union.
As for the United States, there will be some stimulus, regardless of who wins the presidential election. Both candidates favour more infrastructure spending, more military spending, loosening limits on civilian spending, and corporate-tax reform.
The fiscal stimulus that will result from these uncoordinated Group of Seven policies will likely be very modest – at best, 0.5 per cent of gross domestic product of additional stimulus a year for a few years. This means that more stimulus, particularly infrastructure spending, will probably be warranted. Nonetheless, the measures above are a step in the right direction.
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