Fiscal Policy Makes a Quiet Turn Toward Stimulus

Shift in political winds toward populism weakens appetite for austerity

By Greg Ip

Pro-Brexit campaigners protested alongside pro-Europe demonstrators at a March for Europe rally in London on Sept. 3, 2016. The U.K.’s vote to leave the European Union in June was a recent catalyst for a shift in fiscal policies. Photo: Chris Radburn/Press Association/Zuma Press

For years, the world has looked to central banks to deploy whatever tools they had to prop up economic growth. Now, just as those tools reach their limits, governments are quietly stepping up.

Fiscal policy across the developed world is collectively turning more stimulative for the first time since the end of the recession.

This may be the most underappreciated economic development of the year. While the scale of the stimulus is modest in dollar terms, it signals a more profound shift in the political winds.

Globally, the rise of political populism has pushed deficits down the list of priorities while elevating tax cuts and benefits for the working class. With enough critical mass, such measures could persuade central banks to rethink their own super-easy monetary policies, which would undermine the case for today’s rock-bottom bond yields and pricey stocks.

 The fiscal shift is easy to miss, because rhetorically at least, governments remain devoted to cutting their debts. But numbers tell a different story. In major economies including the U.S., Japan and Britain, budget deficits will either be larger this year than last, or larger than originally targeted. J.P. Morgan JPM -0.14 % economists believe that fiscal policy will be positive for developed economy growth this year, instead of neutral or negative, for the first time since 2009.

While that impetus is projected to fade next year, events may dictate otherwise, especially in the U.S., where more borrowing is implicit in both presidential candidates’ plans. This week, Republican Donald Trump unveiled a raft of proposed subsidies and tax breaks for child care and maternity leave, not typically a Republican priority, without saying how they’d be paid for other than cutting waste and abuse.

The near-term catalyst for the fiscal turn was Britain’s vote to leave the European Union on June 23. Not only did the resulting uncertainty threaten global economic growth, it also alerted centrist political parties to how unhappy voters are with the economic status quo.

British chancellor George Osborne quickly abandoned his goal of a budget surplus by 2020. He was nonetheless sacked by the new prime minister, Theresa May, who has moved the ruling Conservative Party in a more populist direction that emphasizes inequality, homeownership and corporate responsibility and dwells less on the budget deficit.

Similar dynamics have also unfolded in the eurozone. In July, the European Commission elected not to fine Portugal and Spain for missing their deficit-reduction targets. 

Not only did Germany’s finance minister, Wolfgang Schäuble, the bloc’s de facto debt policeman, support the decision; he has turned less austere at home, promising more than $2 billion worth of tax cuts and increased child benefits in 2017 and $17 billion of tax cuts in 2018.

To be sure, these measures are small, and they merely keep Germany’s budget surplus from growing. But Jacob Kirkegaard of the Peterson Institute for International Economics thinks bigger stimulus could be in store. Chancellor Angela Merkel is losing support to the populist anti-immigrant Alternative for Germany and “needs the tax cuts to placate restive colleagues,” he says. He notes elections will take place in France, Germany and the Netherlands ​next year, and possibly Spain and Italy, which will further sap the appetite for debt reduction.

For Japan, the impetus was both Brexit and the Bank of Japan 8301 12.79 % ’s introduction of negative interest rates this year, which failed to work as planned; the yen went up and stocks went down. In August, Prime Minister Shinzo Abe unveiled a $73 billion package of infrastructure spending, cash handouts to poor families, and other stimulative measures.

In the U.S., budget caps enacted in 2011 have already been loosened. Meanwhile, Hillary Clinton, the Democratic nominee, is campaigning to boost spending on countless programs, from college education to infrastructure, mostly financed with higher taxes on the rich.

Whether she can get those through Congress is another question. Republicans in Congress would almost certainly grant Mr. Trump part of his wish list, which includes big spending boosts and sweeping tax cuts, virtually none of them paid for.

Mr. Trump’s rise demonstrates that austerity has lost the political energy it had in 2010. “It is the natural inclination of politicians to want to spend more when you have prolonged periods of low economic growth,” says Mr. Kirkegaard. “In that sense we are reverting to the norm.”

Central bankers can take credit for the shift. As the benefits of zero to negative rates have shrunk and the side effects risen, they have exhorted finance ministers to take up the burden of supporting growth. The low rates they have engineered have drastically reduced the cost of servicing debt, which reduces the risk of a debt crisis and delivers finance ministers a windfall.

But even as they welcome the fiscal assist, central banks may have to recalibrate their own plans. In the U.S., U.K., Japan and Germany, unemployment is back to, or below, prerecession levels. This could make the European Central Bank and Bank of Japan feel less compulsion to expand bond buying or push rates further into negative territory, and could encourage the Fed to raise rates a bit more quickly. Bond investors, beware.

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