The global economy is in danger if we don’t pull off this pivot

The golden age of quantitative easing is over and it’s time for global fiscal reflation

PUBLISHED : Monday, 12 December, 2016, 11:03am
UPDATED : Monday, 12 December, 2016, 10:35pm

It is all over bar the shouting. The European Central Bank has just announced its final salvo of quantitative easing (QE) and a few more dribs and drabs may come through from the Bank of Japan, but, in essence, that’s your lot. The US Federal Reserve has already closed its money printing operations and the Bank of England has called time as well.

In the main, the global monetary super-stimulus cycle is over and it is time to move onto the next big policy push for world economic recovery. The signs are very clear the global recovery is struggling to get out of the gates and in need of some extra new impetus. President-in-waiting Donald Trump has already shown his cards in favour of a big fiscal push to boost the US economy in the next few years. QE may be coming to an end, but global fiscal reflation must fill the gap.

The global economy is clearly in need of a new policy shove. In the assessment of the Bank of International Settlements, the central banks’ central bank warned recently that “the global economy seems unable to return to sustainable and balanced growth”. Both the IMF and the OECD concur that the major economies need to sanction more fiscal reflation to boost recovery.

QE and the super-stimulus from zero interest rates have pulled off a minor miracle since the dark days of the 2008 global financial crash. Economic catastrophe has been averted, deeper deflation forestalled and the world economy has salvaged some degree of recovery. But it could have been a lot better than what’s transpired. The loss of recovery momentum now evident across the globe – from the industrial majors to the emerging markets – must be reversed.

Global policymakers’ big beef is that much of the global monetary super-stimulus has been blunted by the actions of fiscal tightening pulling the other way. It is very clear to see in the cyclically adjusted budget deficit for the OECD area, which shows a massive correction between 2010 and 2015, from a budget shortfall of 7 per cent of GDP down to around 2.5 per cent presently.

It means, at the same time the central banks were flooding the global markets with unprecedented liquidity, governments of the major industrial nations were removing valuable potential stimulus with dramatic fiscal cuts. The policy conflict has put world recovery into a potential stall with global GDP growth running under par at a lacklustre 3 per cent rate right now.

With the Fed set to tighten rates sometime soon and global borrowing costs ratcheting up thanks to surging US bond yields, it is no wonder that Trump’s vision of “America First” and expectations of a dramatically expanded US fiscal stimulus have helped to bridge the gap for global equity markets in the weeks following the presidential elections.

Now that markets are focused on the great US reflation trade, Trump had better be as good as his word, always a risk considering his “will-o’-the-wisp” campaign policy equivocations. The markets will obviously need to deal with the future consequences of greatly expanded budget and trade deficits, but, for now, continuation of the US dollar rally and record stock market highs will be deeply dependent on Trump delivering his promised land of higher growth ahead.

Europe definitely needs to up the ante on fiscal reflation, especially since the last rites have just been announced for the European Central Bank’s QE programme in six months time, albeit at a sharply diluted bond-buying rate of 60 billion per month rather than the current 80 billion monthly purchases.

Originally, the ECB was late into the easing game and monetary reflation has since been severely handicapped by the European Union’s obsession with fiscal retrenchment. It is no wonder the euro zone’s recovery prospects have been so hamstrung, leaving GDP growth lucky to muster more than 1.5 per cent over the next year.

Europe is crying out for a massive fiscal reflation, always a tough call with austerity-minded Germany on the case. But without it, youth unemployment, as high as 45 per cent in some countries, carries the seeds of euro zone social discontent and the euro’s future destruction.

The world is at a turning point for monetary and fiscal policy right now. As QE’s healing balm starts to fade, it is time for global fiscal reflation to take over. If it fails, global economic revival and world financial markets will tumble.

David Brown is chief executive of New View Economics