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Who Wins the Fiscal Stimulus Contest Now?

Guest Post by Ned Davis Research

U.S. Sees Biggest Jump

Not surprisingly, the biggest upward revision is to the U.S., now at 26% of GDP, up almost 10 percentage points since the end of 2020. Most other countries have seen a much more modest rise, if at all.

At first glance, this still puts the U.S. in the middle of the pack with respect to announced COVID fiscal support. However, not all stimulus is the same. In Europe, for example, much of the stimulus (often a majority) has been in the form of loan guarantees, which in theory, will ultimately need to be paid back. U.S. stimulus, however, has been mostly grants (such as the Payment Protection Program) and direct payments (via direct checks and enhanced unemployment compensation).

The U.S. was in greater need of this kind of direct support given that the economy doesn’t have the same degree of automatic stabilizers (i.e., built in social support) as many other developed economies. In 2019, public social spending in France and Germany as a share of GDP Who wins the fiscal stimulus contest now? was 31% and 26%, respectively, vs. a much smaller 19% in the U.S. Once accounted for these discrepancies, we argued that COVID-related fiscal stimulus stacked up similarly in 2020 among most developed economies.

The $1.9 trillion American Rescue Plan, however, now puts the U.S. significantly ahead. The following chart shows fiscal spending calculated by the OECD. For their 2020 calculations, instead of announced COVID spending, they looked at the cumulative change in net government lending as a share of GDP.

As you can see, stimulus wasn’t vastly different among the featured countries/regions last year, with the eurozone even having a bit of an edge, due in part to the aforementioned automatic stabilizers kicking in. 

For new fiscal support as of December 2020, the OECD’s calculation utilizes the announced stimulus packages as a share of GDP. On a cumulative basis, this puts U.S. COVID stimulus at around double the eurozone and Japan (with the caveat that automatic stabilizers aren’t accounted for in the post-December 2020 stimulus estimate).

U.S. Takes Economic Lead 

This fiscal edge, as well as a better-than-expected vaccination drive, is what prompted NDR to significantly upgrade their 2021 growth forecast for U.S. GDP to 6.5%-7.0%. Additionally, NDR has upgraded their global growth estimate to 6.1%, which will make the U.S. the largest contributor to global growth in 2021. 

Is There a Limit?

The prospect of rising fiscal debt and its sustainability has hit a nerve among many
investors. Hypothetically, you could deduce that governments would be punished for their lack of fiscal restraint. A reduction in investor demand for Treasurys would theoretically drive up yields. Moreover, textbook economics suggest that large increases in government borrowing would crowd out private investment, as surges for demand in the lending markets would drive up interest rates. But the relationship between borrowing costs and government spending has broken down in recent decades. For some, this has built the case for Modern Monetary Theory (MMT), which, simply put, allows the government to open the spending spigot (funded by the central bank). The only restraint is inflation, which the government would be in charge of
handling. Though NDR is not a proponent of MMT, the low interest rate, growth, and inflationary environments have brought much more fiscal space in the developed world.

Keep in mind that for many years economists, including several central bank heads, had been pushing for a greater fiscal role. Indeed, the surge in monetary stimulus among the world’s largest developed central banks since the Global Financial Crisis has done little to boost long-term growth and inflation. Fiscal spending, however, can be targeted.

But it’s hard to believe that one country (even the U.S.) could get away with excessive spending without some penalty. That is one of NDR’s key criticisms of MMT, in that it takes dollar superiority for granted. Although the U.S. dollar enjoys the status of the world’s most actively held and traded currency and it takes a very long time for currency regimes to change, a tipping point could eventually come unless there’s an increase in revenues. Alternatively, governments could also engage in spending reforms that boost potential growth, thereby keeping debt/GDP ratios steady via stronger economic growth. 

Fiscal policies can either boost or reduce potential growth

Boost Reduce
Infrastructure investment
Zombie companies
Promote innovation and technological change
Reduce competition (increased trade barriers, rent seeking)
Promote competition (reduce barriers to entry, simplify taxes)
Increase regulation
Reduce negative externalities
Downplay market forces

The table above shows a non-exhaustive list of ways fiscal policies can either boost or reduce potential growth. This means the type of spending, not just the quantity, will be of rising importance.

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Trek FG 21-48

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