One threat to economic recoveries this year is that governments withdraw their generous fiscal support too quickly. So far, that threat does not seem to be an imminent one. That said, the level of fiscal support is set to remain more generous in the US and Canada than in most other major developed economies.
- One threat to economic recoveries this year is that governments withdraw their generous fiscal support too quickly. So far, that threat does not seem to be an imminent one. That said, the level of fiscal support is set to remain more generous in the US and Canada than in most other major developed economies.
- If the temporary pandemic-related measures are withdrawn too soon, then there is a risk that bankruptcies and unemployment rise, and recoveries are snuffed out before they become well-rooted. This risk is especially pertinent for developed markets as they have generally seen the biggest amount of discretionary policy stimulus. (See Chart 1.) Even worse, governments could bring in additional tax rises and/or spending cuts to try to reverse some of the rise in public sector debt seen during the pandemic.
- Accordingly, it might seem worrying that government deficits are set to shrink relatively sharply this year. (See Chart 2.) However, deficits are likely to remain far higher than they were before the pandemic struck. Moreover, the projected drop this year is mainly a reflection of the rebound in economic growth that is likely. This will reverse the automatic stabilisers that have pushed up borrowing (e.g. the drop in taxes as fewer people have worked). If that pick-up in growth does not materialise, then government deficits will not shrink as much, if at all.
- Meanwhile, much of the discretionary fiscal stimulus has taken the form of multi-year programmes, so the support for the economy won’t abruptly end once the worst of the pandemic is over. These include the “Next Generation EU” fund in the euro-zone and a multi-year boost to investment in Canada.
- Even the more temporary programmes are only likely to be ended as planned if economies look strong enough to withstand it. Crucially, governments are still being very quick to extend their assistance if necessary. For example, many European countries have, in recent months, extended their furlough or reduced-hour schemes for the labour market when lockdowns have been reimposed.
- Note, too, that there is still no pressure on governments to rein in their spending from bond markets. This is partly because central banks are still buying a lot of government bonds – something we expect to continue for a while yet. We doubt that the US Fed will begin tapering its asset purchases this year, while the ECB has pledged to continue net purchases until March 2022. With governments’ debt burdens still looking generally sustainable, there remains little immediate prospect of a wave of austerity. (See here.) Any tax rises we see will be more to target particular groups for political reasons than to bring deficits down sharply.
- So, we do not think that governments are about to throw a spanner into the works. That said, some countries will receive more support this year than others. In particular, the prospect of the big new stimulus programme in the US is likely to keep it at the front of the pack in terms of discretionary fiscal support for its economy. This is one of the reasons why we expect the US to outperform other major DMs this year.
Chart 1: Discretionary Fiscal Response To COVID-19 (Extra Spending & Foregone Revenue as a % of GDP)
Chart 2: Total Government Borrowing (As a % of GDP, CE forecasts)
Source: Capital Economics
Vicky Redwood, Senior Economic Adviser, email@example.com