- Central banks have relied on rate cuts to stimulate their economies, but HSBC has argued government spending may also be needed to fight recessions.
- Cutting interest rates, already close to or in negative territory, may not prevent slowdowns alone due to geopolitical pressures, HSBC said.
- The bank said fiscal policy can lift wage growth and boost GDP growth, and combined with monetary policy, is less likely to create asset bubbles.
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Central banks have relied on rate cuts to stimulate their economies, but HSBC has argued government spending may also be needed to fight recessions.
Despite recent rate cuts from the Federal Reserve, European Central Bank (ECB), and other central banks around the world, the global economy has slowed to its lowest level since the eurozone crisis in 2012, HSBC economists said in a note to clients. Geopolitical uncertainty due to the US-China trade war, Brexit, regional tensions in the Middle East, and other ongoing disputes threaten to throttle growth even more, the bank said.
HSBC highlighted a recent analysis by the Organisation for Economic Cooperation and Development, which concluded that “combined monetary and fiscal policies were not only much more supportive for GDP growth than QE alone but are also much less likely to create asset bubbles.”
What’s the difference between monetary and fiscal policy?
Monetary policy revolves around managing interest rates and the money supply to balance growth and inflation. Fiscal policy centres on governments taxing and spending to boost or slow the economy.
Central banks control interest rates and money supply in many countries, while the government controls taxing and public spending.
What did HSBC say?
Fed Chief Jerome Powell and ECB President Mario Draghi have cut rates – lowering borrowing costs and discouraging saving – in a bid to shore up economic growth and stave off recession. However, HSBC warned the effectiveness of rate cuts may be diminishing as they enter negative territory, creating greater scope for government spending and tax cuts.
“Central banks, particularly the ECB, have become increasingly vocal that they are very close to reaching the limits of what monetary policy can do to address this slowdown and low inflation, and that there is a greater role for fiscal policy,” the bank said.
Fiscal policy could also reduce inequality, or exacerbate it less than more extreme monetary policy.
“Even in the short term, fiscal stimulus can certainly have ‘fairer’ distributional consequences than unconventional monetary policy if, for instance, it raises real wage growth, rather than raising asset prices,” HSBC said.
However, HSBC warned fiscal stimulus has to bolster productivity and wages to boost the economy’s growth potential, or governments could end up with soaring deficits and debt piles.
“[Central banks] are calling for fiscal and other policies designed to raise investment and improve human capital in order to drive stronger productivity and wage growth. Only that would raise the natural or equilibrium interest rate (r*) over time.
“Otherwise, rather than raising potential growth, fiscal stimulus could simply lead to higher budget deficits and debt-to-GDP ratios and risk the re-emergence of debt-sustainability concerns.”