Emiel wrote recently about monetary policy nearing impotency, as interest rates approach the reversal rate (when rates are so low they cause lending to contract rather than fulfil its expansionary purpose) and the size of balance sheets and bond purchases are becoming more political.
Fiscal policy seems a logical lever for those trying to perk up their economies to try next. However, given existing budget deficits and high debt burdens around the world, fiscal expansion – irrespective of whether the policy will be explicitly underwritten by central banks rather than finance ministers – may still prove difficult for politicians to stomach.
There has indeed been resistance to more fiscal spending in most countries, but the tide seems to be turning. Governments want to take advantage of record-low interest rates to ‘future proof’ their economies, while simultaneously framing this so that it doesn’t just sound like unbalanced budgets and more debt to the electorate. It’s therefore all about climate financing, green deals, infrastructure spending, and social transformation.
In LGIM’s latest CIO Outlook, my colleagues Chris, Hetal, and Alex discuss why the UK and the Bank of England may be at the forefront of this development in approaches to economic stimulus.
New Zealand is another interesting example of this shift: as a country with a budget surplus, low debt burden and low borrowing costs, it could choose to be a trailblazer for helicopter money.
Last week, New Zealand’s finance minister announced plans to bring forward major infrastructure investments to benefit “generations to come”. The size of the package appears to be an additional 2% of GDP over the next few years. The currency market reacted positively to this news, with the Kiwi dollar rallying.
It’s almost a perfect passing of the baton from monetary to fiscal policymaking: the central bank, whose mandate changed earlier this year to include full employment alongside price stability, slashed rates enthusiastically earlier in the year and indicated this month it was nearing the end of the cutting cycle. Although no coordination between the government and central bank was mentioned, we don’t think the order of events is entirely a coincidence. In other words, one can vaguely hear the sound of a helicopter getting ready for lift-off.
Although New Zealand is not a major capital market, we can watch it for signs of what may happen to asset prices if other countries do unleash their fiscal firepower.
First, as noted, the local currency strengthened. More infrastructure spending is inflationary and increases the potential growth rate, in turn pushing up interest rates, which benefits the currency. Just remember what happened with the US dollar when President Trump, who campaigned for more infrastructure spending, was elected in 2016.
Increased levels of spending financed by issuing more debt, however, will put upward pressure on bond yields, so a fiscal investment package is generally not good news for bond markets.
And from an equity perspective, fiscal expansion should in theory benefit corporate earnings through higher economic growth. Last year we implemented a ‘Rebuilding America’ stock basket in our more dynamic multi-asset portfolios, given the chances of increased fiscal spending in the build-up to the US Presidential elections next year. This basket focuses on the companies involved in building the infrastructure, which should directly benefit from increased infrastructure spending.
This kind of scenario mapping is an essential part of our team’s approach to portfolio construction and management. Without it, the onset of helicopter money could leave some investors in a spin.