Central bankers have been warning for a couple of years that monetary policy is suffering diminished returns in its effectiveness and needs the help of fiscal spending.
But to governments focused on debt and deficits in the aftermath of the GFC, such calls fell on deaf ears.
At least that was the case until the rise of populist political movements around the globe increased recognition that a political imperative to holding office may include fiscal expansion to aid monetary policy and support growth.
It is against this backdrop that PIMCO, in its latest quarterly outlook authored by Joachim Fels and Andrew Balls, says that fiscal policy is likely to become an increasingly important tool in developed markets.
Fiscal policy “could also become a bigger source of surprises next year, most in the form of more stimulus”, Fels and Balls write.
They highlight that Japan has already announced a “package amounting to around 1.5% of GDP”, that the UK government is relaxing its fiscal strictures after Brexit, and they say that in Europe because “several large countries (Germany, France, Netherlands) will hold general elections next year, policy may well turn more expansionary than currently announced”.
Likewise in the US, PIMCO believe the fiscal spigot will be opened after November’s election, adding that “expectations for stimulus after the election, irrespective of who wins it, could already lift confidence and thus encourage corporate and consumer spending well before implementation”.
That is important for asset prices and financial markets.
Fels and Balls say (our emphasis):
To be sure, more fiscal action would be a big deal for financial markets as it could shake up the newfound consensus that we are in secular stagnation, that central banks are the only game in town, and that therefore rates will remain low forever.
The big question though is whether fiscal stimulus is good or bad for risk assets.
In Japan, BoJ governor Kuroda has, in targeting the 10-year yield, already signaled that he is going to continue to follow benign monetary policy if the Japanese government’s fiscal policy and the BoJ’s own abandonment of the money base target do eventually work to increase inflation until it has risen and stabilised at 2%.
In doing this, Kuroda is trying to make monetary policy pro-cyclical in Japan to support growth and inflation and entrench them back into the Japanese economy.
Surely after all these years in the economic doldrums, central banks across the globe will follow the BoJ’s lead and let growth and inflation run a little before stamping on the monetary brakes.
But what other central banks do with monetary policy settings is less certain, Fels and Balls say.
“It is not clear whether more fiscal stimulus will turn out to be a boon or a gift of poison for risk assets, given its likely impact on central banks’ reaction function,” they conclude.
NOW HERE’S PIMCO’S 17 charts about the global economy to keep in mind for the next year
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