Morgan Stanley analyst Gerard Minack is always an intriguing read: In his latest note he talks about output gaps and fiscal policy, and argues that fiscal policy has been particularly robust during this slump, in part because advanced economies have seen such a big gap between potential output and actual output.
Economists have debated the short- and long-run efficacy of fiscal policy for decades. But it seems fair to say that fiscal policy has been more effective than many had expected through the current cycle. This may reflect the now widely appreciated difference between economic downturns that include financial crises versus ‘normal’ economic cycles. The downturns in ‘normal’ post-1945 economic cycles were often caused by policy errors (excess tightening). Few cycles in major economies, Japan aside, included systemic financial stress of the type seen over the past five years. Such cycle downturns typically did not affect trend growth. Consequently, the recovery saw catch-up growth running at a faster rate than in the period prior to the downturn.
To that end, he produces a nifty chart looking at Japan, which is interesting its own stimulus cycle, and which has been in a state of poor output, post-crisis for the past 20 years.
It basically shows why investors are so bullish: Expectations of stimulus.
Photo: Morgan Stanley
Of course, this leads to a question about the US, which is seeing creeping fiscal consolidation.
How Japan-like is the US economy, and can markets really thrive if spending growth gets cut.