The next big consensus view in economics has arrived

The crowd is gathering on the need for government spending. (Photo by Hulton Archive/Getty Images)

It’s official: calling for more government spending is a mainstream consensus view.

For years following the financial crisis, policymakers around the world sought to follow the IMF-endorsed post-crisis response of reducing debt burdens to ease the stress of recession on various economies.

This mostly simply involves cutting government spending and raising taxes.

This is known as austerity.

In a series of notes to clients out over the weekend, analysts at Bank of America Merrill Lynch summarize the case for fiscal stimulus, who the big corporate winners might be, and which countries could still have some time to go before they jump all-in on fiscal stimulus.

Of course this is not the first we’ve written or read on the topic — see here, here, here, and here. Additionally, this is not a new view as many in the economics conversation, particularly in the blogosphere, have been on this theme for years.

But BAML is a major, influential research house on Wall Street and their summation of the view, frankly, is going to carry more weight in investing and policy-making circles.

And so I think BAML’s overview of how the global consensus view got to this point is important to keep in mind as we begin working through the implications of what it means when who Paul Krugman would call “Very Serious People” all start agreeing that fiscal stimulus is a good thing.

Here’s BAML (emphasis added):

“In the immediate aftermath of the Global Financial Crisis, a number of economies aggressively eased both monetary and fiscal policy. But within a relatively short period of time, that stimulus was replaced by fiscal austerity as governments over-estimated how quickly growth would rebound, fretted about growing debt levels, and passed the buck to central bankers. Conventional wisdom within mainstream economics viewed monetary policy as the primary tool for stabilizing an economy after a recession; fiscal policy was judged a less desirable and less effective alternative.

The recent re-emergence of support for fiscal easing has occurred in two stages. The first was the fading appeal of austerity as recoveries meandered, interest rates continued to fall, and voting populations grew weary of continued belt-tightening. Boosts to consumer and business confidence from focusing tight fiscal policy on reducing debt levels — derided by critics as “confidence fairy” stories — simply failed to materialise. A key turning point was the IMF’s admission in 2013 that it had dramatically underestimated the damage to growth caused by fiscal austerity. That analysis undercut a key argument in favour of austerity, as tight fiscal policy often reduced the denominator of the debt/GDP ratio even more than the numerator.

This period was marked by the confidence-sapping debt downgrade, fiscal cliff and government shutdowns in the US; by a double-dip recession in the Euro area, and by the unexpectedly sharp contraction in activity in the wake of Japan’s consumption tax hike. China eased quite dramatically from 2008 to 2010 — by some estimates its stimulus amounted to nearly four-times that of the US post-crisis response when scaled to the size of its respective economy — and did not see a sharp contraction in growth as the stimulus faded. While Chinese authorities have become more circumspect of large-scale fiscal easing in recent years, they did not aggressively tighten fiscal policy as most other large developed markets had by 2011 or 2012.

That has changed over the past year or two, as policy has gradually drifted from a contractionary stance to one that is slightly accommodative. In the US, the net contribution of fiscal policy to GDP growth has moved from a sizable negative to a slight positive. Similarly for the Euro area, fiscal policy has switched from a headwind to a modest tailwind. Earlier this year, Japan decided to postpone the next round of its sales tax hike until October 2019 (from April 2017). Fiscal policy in China remains modestly supportive as the economy undergoes its structural transformation.”

Certainly, more to come on this.

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