Searching for Stimulus

The global economy seems headed for a slowdown. The IMF now expects global growth this year of 3.3%, a drop of 0.2 of a percentage point from its previous forecast. Growth in the advanced economies is projected to be particularly feeble, with expected U.S. economic growth of 2.2%, growth of 1.3% predicted for the Eurozone , and Japan’s growth anticipated to be 1%. Of course, a breakdown of U.S.-China trade talks, the imposition of new U.S. tariffs on European cars or a disorderly Brexit could disrupt the forecasts. Can government policymakers improve these conditions?

Central banks have limited policy space. In the U.S., the Federal Reserve has made clear that it does not expect to raise the Federal Funds rate this year, and retains the option of lowering it if conditions deteriorate. Some–including one of President Trump’s anticipated nominees to the Board, Stephen Moore–are already calling for lower rates. But the current Federal Funds rate of 2.5% does not give the central bank much scope for lowering it.  Japan’s central bank already has negative nominal rate targets, while the European Central Bank’s policy rates include a lending rate of zero percent and a negative deposit facility return.

If monetary policy is constrained, what else can policymakers do? Adair Turner, former chair of the United Kingdom’s Financial Services Authority, believes that zero interest rates means that the time has come for “massive fiscal expansion” financed by central banks. He acknowledges that excessive monetary growth can be harmful. But, he argues, when faced with “slow growth, political discontent and large inherited debt burdens…”, policy measures that in other times would be seen as radical need to be considered.

Martin Wolf of the Financial Times is also concerned about the current low interest rates, which he attributes to secular stagnation. He believes that the low rates have created a disinflationary debt overhang, and calls for the use of fiscal policy to supplement private demand. Similarly, Mohammed El-Erian of Allianz points to Japan’s continued low growth as evidence of the limitations of monetary policy. He calls for looser government budgets that raise productivity through spending on education and infrastructure.

The recent record of increased deficits in the U.S. gives some guidance on the impact of a fiscal stimulus. Lower taxes did increase GDP growth in 2018, but the effect has faded and GDP is returning to its trend growth. Corporate taxes also declined, and as a result, the budget deficit widened. The Congressional Budget Office has forecast that the budget deficit will increase from 3.5% of GDP in 2017 to 5.4% in 2022, and the impact on the budget will persist.

The borrowing required to finance these deficits will reinforce the U.S. position, along with Japan and China, as one of the largest debtor nations. As in Japan, government debt represents a significant amount of U.S. total debt. The U.S. stands out, however, for increasing government debt during an expansionary phase of the business cycle when ordinarily debt shrinks. Other advanced economies have used this opportunity to lower their debt burdens.

Olivier Blanchard, former chief economist of the IMF, spoke about government borrowing at this year’s meetings of the American Economics Association. He pointed out that the ratio of debt to GDP need not rise as long as the growth rate of GDP exceeds the interest rate on government debt. That condition has been met since the 19^th century  except during the decade of the 1980s. Moreover, the “crowding out” of private investment is less of a concern in a world of low interest rates.

There is one other aspect of fiscal expansion that should be considered: the impact on a country’s current account, and the impact on other countries. Menzie Chinn of the LaFolette School of Public Affairs at the University of Wisconsin and Hiro Ito of Portland State Universityhave investigated the determinants of global imbalances. Using data from 24 industrial and 138 developing countries between 1972 and 2016, they report: “Fiscal factors determine imbalances, and have accounted for a noticeable share of the recent variation in imbalances, including in the U.S. and Germany.” In the group of industrial countries, a one percentage point increase in the deficit scaled by GDP leads to a 0.42% increase in the current account deficit, similarly scaled.  A significant part of the fiscal expansion, therefore, is transmitted to the rest of the world.

If advanced economies do share low growth rates and constrained monetary policies in common, then a coordinated fiscal expansion may be the best way of generating growth amongst them. But the record on fiscal coordination is, at best, mixed. All the members of the Group of Twenty enacted stimulus policies of different magnitudes during the global financial crisis. However, an earlier agreement in 1978 by Japan and Germany to enact expansionary fiscal measures while the U.S. decontrolled energy prices did not turn out so well. The German fiscal stimulus coincided with the second oil price shock of the decade, but the former was blamed for the subsequent increase in inflation. This experience confirmed German views of the futility of discretionary policies.

The chances, therefore, of a coordinated fiscal expansion among the advanced economies in the absence of another global shock are low. If this means that we do not have temporary surges in growth fueled by lower tax rates, then the long-run cost is low. But all the calls for fiscal policy cited above are for spending measures that would boost productivity. In the long-run, growth will only return if productivity increases, as it did in the 1990s in the U.S. In addition, any tax cuts should be designed to benefit those who have not shared in the gains of globalization. The largest increases in income in the U.S. have accrued to those in the upper tiers of the income distribution. Those below deserve a stimulus that actually benefits them