The yield curve has been caught in a “flattening vortex” for the better part of a decade and the only way out is non-Ricardian fiscal stimulus.
That’s the message from Deutsche Bank’s Aleksandar Kocic, as conveyed in an October 28 email to clients seen by Heisenberg Report.
As documented here earlier this month (and again last week in the context of the exploding budget deficit), the Trump administration’s tax cuts have run into a classic Ricardian equivalence problem. Have a look:
Through Q2 2019, the net economic stimulus from the tax cuts appears to have been almost entirely offset by private sector belt-tightening. Indeed, the chart above shows that in the two quarters immediately following the Trump tax cuts, the increase in private-sector net savings offset the fiscal belt-loosening – and then some. Through the first half of 2019, there was just a small net stimulative effect.
When considered in conjunction with the post-crisis monetary policy response, the US economy has now experienced a decade of stimulus, with the foray into late-cycle, deficit-funded fiscal largesse coming with growth already running at or above potential, Kocic wrote on Monday.
And yet, a sustained rise in inflation to target has proven elusive, as has a truly robust recovery.
“The most recent fiscal stimulus has been largely Ricardian equivalent; that is, the dis-saving of the Federal government has been largely offset by increased private sector savings, and as fiscal stimulus fades, GDP trackers suggest that growth is slipping below potential”, Deutsche’s Kocic says.
This suggests that the “flattening vortex” may be virtually impossible to escape barring a rethink of the stimulus mode. As Kocic puts it, “it is challenging to see how pursuing any maneuver (fiscal or monetary) in the traditional paradigm can generate escape velocity from the flattening vortex”.
That goes double when you consider the macro backdrop, characterized as it is by lackluster global growth (the IMF and the OECD recently slashed their outlooks again, to reflect the slowest pace of growth since the crisis), myriad structural disinflationary factors and the stubbornly resilient US dollar.
So, what of non-Ricardian fiscal stimulus?
Well, the problem there is that it requires having an uncomfortable discussion around how and to what extent stimulus should be geared towards facilitating wealth redistribution.
This, Kocic says, appears “as necessary as it is economically and politically difficult to achieve”. Here is the crucial passage:
Although the attitude towards all kinds of inequality like slavery, racial and gender exclusions had been revised in the past, the same cannot be said for wealth inequality. The resistance against radical redistribution of wealth has been remarkably robust and resilient across a variety of political systems, from dictatorships, monarchies, peasant societies, to post-industrial formations and democracies. The wealth protection instinct has proven to be one of the strongest sociopolitical forces in human history.
If those attitudes remain firmly entrenched, the institution of non-Ricardian fiscal stimulus will face insurmountable opposition, even as it increasingly appears to be the only viable option for resurrecting robust growth, arresting the slide in inflation expectations and, ultimately, rescuing the curve from a seemingly intractable secular flattening trend.