The end of austerity as we know it?

24 September 2019

The arguments are adding up in favour of fiscal expansion, putting pressure on governments to act, says Anthony Rayner, manager of Miton’s multi asset fund range.

The September European Central Bank (ECB) meeting was, on many levels, a bit of a non-event. What we thought was of most interest was not the announcements on monetary policy but on fiscal policy, not typically the remit of central banks. Specifically, there was unanimity around the need for fiscal policy to join monetary policy and, more precisely, that fiscal policy should be the main policy from now on.

This adds to growing pressure on governments to move beyond the austerity narrative. Extreme monetary policy, in the form of very low interest rates and QE, is increasingly perceived as unhelpful in generating sustainable economic growth, damaging to banks, contributing to inequality and uncompetitive by other nations.

Just like globalisation is no longer the dominant narrative, so we believe it will be with austerity. Unlike monetary policy, a material change in fiscal policy won’t be by the flick of a switch. Central banks are generally designed to act quickly, without the checks and balances that guide or restrict politicians in democracies. Indeed, the impotence of democratic governments has been further compounded by increasing polarisation.

While political obstacles remain, the economic rationale for expansionary fiscal policy has been complete for some time. A number of large economies with infrastructure deficits, such as the US, Germany and the UK, could all do with a more direct boost to their real economies and are currently borrowing at very low, or negative, interest rates.

The Eurozone is an interesting example. The region has been repeatedly constrained from carrying out expansive fiscal policy by the northern countries but, of late, there have been a number of important developments in Germany, the political and economic powerhouse of the region. The material slowdown in the German economy, geared as it is into the global economy and the trade wars, has forced many to look for answers beyond monetary policy.

A number of ideas have been floated in Germany recently. One was for significant investment in a climate change protection programme, partly as it is needed and partly as it might allow politicians to save face and better navigate some of the significant political and constitutional constraints on German fiscal expansion, such as the “Schwarze Null” policy (black zero) and the constitutionally enshrined “debt brake”.

Either way, we are a long way from fiscal policy embracing Mario Draghi’s 2012 “whatever it takes” pledge on monetary policy. The degree of the German slowdown will, no doubt, play an important part.

The political environments are different in the UK and the US; they have less fiscal space than Germany but they don’t have the degree of fiscal hawkishness that Germany has had traditionally, though there is significant polarisation politically, which can make change hard.

The timeline is therefore unclear, even if the likelihood has increased. But even when, or if, fiscal policy becomes more expansive, many questions and risks remain.

Would a discipline ensure that it was designed to benefit economic cycles rather than electoral cycles? If the expansion takes the form of government spending, will infrastructure spending to improve productivity be a focus, as this typically sees high fiscal multipliers? Would it be coordinated globally, as that would generally make the impact more powerful too? This sounds unlikely, as coordination between nation states has generally fallen in recent years but this might be different around climate change initiatives, the effects of which are not constrained by borders. What would be the impact in financial markets, would it push bond yields up materially and see economically sensitive equities outperform? Lastly, what path do we take to reach expansive fiscal policy: are currency wars and a recession stepping stones to expansive fiscal policy?

Going forward, the economic and social case is strong, but politics remains divisive and will likely act as a significant constraint. We do know that monetary policy has reached the end of the road, conceptually at least, and whether Germany enters a technical recession on its Q3 data will no doubt prove important for the impetus of fiscal policy. We can also observe a consensus building that those with fiscal space (i.e. those economies not dogged by excessive public debt) should start to implement policies to stimulate growth.

The question comes down to whether economic pain pushes fiscal policy high enough up the political agenda. In the meantime, what choice do central banks have, if expansive fiscal policy is not forthcoming?

As for our portfolio construction, we remain broadly positioned for more economic pain, rather than expansive fiscal policy: quality growth in equities, duration risk but limited credit risk in bonds, diversified property exposure and a gold position. However, our emphasis on liquidity across assets means that a change to this environment can be reflected quickly across portfolios.

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