Despite extraordinary easing measures by the major central banks, including multiple rounds of QE and negative rates, global growth has remained below its pre-crisis levels and we have seen multiple ‘growth scares’ in the last few years. Inflation has been hovering near historical lows and nominal GDP has been expanding at a slow pace, making it harder to deleverage and reduce debt.
With limits to what monetary easing can deliver, calls for more expansionary fiscal policy (and more coordination between monetary and fiscal policy) have picked up. Some countries have already started to ease their fiscal stance or scale back austerity plans.
One argument is that fiscal expansion can increase growth directly by adding to the total demand in the economy, while monetary policy can only do this indirectly by lowering the cost of money and increasing liquidity. Tax cuts can also add to demand provided that consumers or companies spend rather than save.
But well thought through fiscal expansion – especially increasing public investments – can also increase future growth and productivity, boosting GDP in the long term. This is especially true in areas that may be limiting growth today, such as deteriorating infrastructure, but also in areas that may affect future growth, such as energy efficiency or structural reforms in the labour markets.
What’s more, some investments can be done quickly. While traditional bricks-and-mortar investments take time, it’s usually faster to maintain existing infrastructure or invest in technology.
Governments can raise new funding at record low costs, sometimes even at negative rates, supporting the case for increased investment. Investing these cheaply obtained funds into productive projects can limit the risk of unsustainable increases in public debt.
With the prospect of lower interest rates for longer, fiscal expansion also carries a lower risk of crowding out private investments and increasing the cost of capital. Public investments could mobilise private investments too.
However, even potentially growth-supportive investments carry risks. A recent IMF study showed that public investments boost growth and can ultimately reduce public debt, but mostly in countries with high ‘investment efficiency’. This suggests that countries with weaker institutions and more complicated business procedures may benefit less from higher infrastructure spending. Projects may also fall victim to politics.
Coordinated fiscal and monetary expansion could also diminish the credibility of inflation targeting, which may ultimately discourage policymakers from easing through far-reaching new tools such as ‘helicopter money’.
Countries that suffered from the crisis, especially in the European periphery and in emerging markets, have seen a fast increase in debt in recent years. These countries have less ‘fiscal space’ to increase debt further without triggering sustainability concerns, but they may still benefit from the spill-over of increased investment demand elsewhere.
Political preferences also matter. Where electorates prefer lower state engagement and lower deficits, the scope for expansion is limited. Some countries are concerned by the looming costs of population aging, but investing now to improve productivity or limit the future costs of climate change may help to overcome these impending challenges.
Adapted from Magdalena's Fundamentals piece: Time for coordinated policy to revive growth?