It’s a familiar refrain: With central banks pushing the boundaries of what can be accomplished with ultra-accommodative monetary policies, the path to economic vibrancy goes through fiscal stimulus.
Even if there’s a will among central bankers (one is reminded of Haruhiko Kuroda’s famous reference to Peter Pan), there may not be a way.
Policy rates in some locales have reached the theoretical lower limit, and while balance sheets can always be expanded, large-scale asset purchases risk the impairment of market functioning. Past a certain threshold, efforts to keep the world flush with liquidity paradoxically increase the risk of flash events, as entire corners of the investing universe (think: the JGB market) are cornered by the benefactors with the printing presses.
Meanwhile, round after round of accommodation inflates the value of financial assets, which are overwhelmingly concentrated in the hands of the wealthy. That, in turn, exacerbates inequality, as those lower on the socioeconomic totem pole wait for the vaunted “wealth effect” to finally “trickle down”. (It never does – not really, anyway.)
(Evolution of wealth concentration by income group, Q2 2019 versus Q3 2006)
And so, calls are growing louder for governments with the capacity to spend to loosen the purse strings. Indeed, with borrowing costs artificially suppressed, there has arguably never been a more opportune time for debt-funded fiscal stimulus.
We say “arguably”, because fiscal hawks are clinging to the notion that somehow, budget bragging rights should take precedence, even when jobs are at risk, and countries like Germany are mired in the deepest manufacturing slump since the crisis.
“With interest rates so low in Europe, many countries have the space to do more fiscal spending without jeopardizing their debt sustainability”, BofA wrote this week, noting that “while fiscal spending can also vary in its efficacy… counties that have run higher fiscal deficits over the last decade have tended to have stronger rates of GDP growth”.
Of course, there are also calls for greater coordination between monetary policy and fiscal policy. These kinds of “public-private” partnerships are one of the key tenets of modern monetary theory and will likely inform the debate going forward, especially as models linking inflation to labor market slack break down.
Given that this debate is set to take center stage in 2020 (especially considering progressive politicians in the US openly advocate MMT or, at the least, a soft form of it, while Donald Trump’s calls for negative rates and deficit spending amount to the same thing), it comes as no surprise that fiscal policy is the topic of Goldman’s latest “Top of Mind” note, entitled “Fiscal Focus”.
As a reminder, the bank’s “Top Of Mind” series are expansive takes on whatever the market topic du jour happens to be. They combine interviews with Goldman’s own employees and also with outside sources in an effort to provide a balanced and comprehensive assessment on whatever seems to be the most important question on market participants’ minds (hence “Top of Mind”). The bank’s Allison Nathan conducts the interviews and collates the charts and analysis.
Below, find selected excerpts from the bank’s interview with Olivier Blanchard, former Chief Economist at the IMF, followed by one bonus excerpt from Nathan’s sit-down with the bank’s own Jan Hatzius.
It should be emphasized that these “Top of Mind” notes are thousands upon thousands of words long, span dozens of pages and contain a veritable smorgasbord of visuals, so what you read below hardly scratches the surface – it’s merely intended to sketch the broad contours of the debate that will be at the forefront of the macro narrative in 2020.
Via Goldman (abridged)
Allison Nathan: Discussions about the use of fiscal stimulus today often start with the fact that interest rates are very low, and markets expect them to remain low for the foreseeable future. But shouldn’t we worry that markets are wrong? Olivier Blanchard: Nothing is for sure, and the markets could be wrong. But there are reasons to think that they are right. First, low real rates today are not a fluke; they have been on a declining trend since the mid-1980s. Second, while I wish we better understood the role of the various secular factors behind this declining trend, most of the factors we have identified are likely to persist. And, third, the market’s conviction in this view is notable. The yield curve suggests markets are convinced that rates will remain low, and option markets are pricing a very low probability of rates increasing. So, I think it is reasonable to assume that low rates will continue. But even if markets turn out to be wrong, governments today can lock in current low rates for 10, 20, even 30 years by issuing long-maturity bonds.
Allison Nathan: So are big fiscal expansions less problematic for debt dynamics today than in the past? Olivier Blanchard: Nearly by definition, when interest rates are low—and especially if the interest rate is lower than the growth rate—debt dynamics are more favorable. The future costs of deficits are lower.
Allison Nathan: Should we be worried that your advice will lead to large deficits/high debt levels, which will weigh on growth and increase vulnerability to crises down the road? Olivier Blanchard: Yes, I worry. But to be clear, I’m not advocating fiscal indiscipline… I’m advocating fiscal discipline adapted to the current environment, which allows governments to be a bit more relaxed about debt than in the past. Now, if investors panicked in the face of rising debt levels, growth would take a hit. And very high debt levels could have an adverse impact on growth by creating a debt overhang, making borrowing challenging. But none of the major economies are anywhere close to that situation today.
Allison Nathan: Is Europe likely to pursue the fiscal expansion it needs? What explains the hesitancy to do so? Olivier Blanchard: I’m just back from Europe, and I had many discussions about this. The fiscal rules in the region are a constraint. They are not always respected. But they still affect behavior. For example, countries like Italy are scared of the market’s punishment if they violate them. These rules come from somewhere—a strong fear of debt and inflation in countries like Germany, which has historical validity. This fear is so deeplyrooted that in some cases there is a refusal to even consider the macro aspects of fiscal policy; the view is debt is debt and the less you have of it, the better.
Allison Nathan: How do your views on a larger use of fiscal policy differ from proponents of MMT, who call for governments to finance deficits by printing more money? Olivier Blanchard: Not for lack of trying, I’m honestly not sure what MMT proponents believe or not. But if we leave MMT aside, and focus on the argument that large deficits can be money financed without major problems, I think that argument is wrong. You can indeed finance deficits with interest-paying money, which is effectively identical to financing deficits via bond issuance, except instead of paying interest on your debt, you’re paying interest on reserves held by the central bank. But if you aim to money finance the deficit without paying interest on money, then the large deficit implies that you have to print an enormous amount of non-interest paying money relative to the existing demand. This leads to a massive increase in the supply of noninterest paying money against limited demand, and pushes the interest rate down to zero. So you end up with an interest rate at zero and a very large deficit. The likely eventual outcome is overheating, and eventually high or hyperinflation; the old notion that printing a lot of money eventually leads to hyperinflation still holds today, and the only way to avoid it is by paying interest on the money, just as you do on a bond issuance. I’m not sure that money financing a large deficit without paying interest on the money is what MMT proponents are advocating. But if it is, they’re wrong.
Allison Nathan: So can government simply print more money to finance higher deficits with little risk? Jan Hatzius: I wouldn’t go as far as to say that because a government can’t technically go bankrupt, deficits are never a problem. Even most proponents of MMT will say that inflation is a constraint; so, you should run and monetize deficits until inflation becomes a problem and then you should rein it in. In that sense, I view MMT as a very aggressive form of Keynesian macroeconomic policy, which is usually a good idea when the economy is depressed and far away from full employment, but a much less good idea when you’re at full employment. From that perspective, I was sympathetic to many of the policy prescriptions of MMT proponents in the early years after the crisis because they got you to the right place, whether or not you agreed with all of the tenets. Today, I think the merits of employing MMT policy prescriptions depend on where you sit. In the US, I’m generally not sympathetic because the economy is effectively at the Fed’s dual mandate, and very aggressive stimulus could ultimately do more harm than good in terms of inflationary pressures. Even outside the inflation risk, a sudden decision to run a much larger annual deficit could push up long-term interest rates in a way that destabilizes the financial markets and ultimately the real economy. It’s just not worth the risk given how well the US is doing from a cyclical perspective. In Europe and to some degree Japan, by contrast, the economy would likely still benefit from aggressive stimulus.