Change in the US fiscal stance, (+ = stimulus, % GDP)

Source: CBO, IMF, ABN AMRO Group Economics

Will US fiscal stimulus lead to overheating? Some heavyweight economists have argued that new the US fiscal proposal will lead to overheating. Some have even assumed that discretionary measures will translate one-for-one into higher growth.

While we have significantly raised our US growth forecasts on the back of these measures, the degree of forecast revision (around +2.6pp for 2021) is not nearly as large as the package itself. Why is this? Firstly, much of the spending proposed is not really ‘new’ per se, but rather it extends existing financial support that would otherwise expire – this applies for instance to the top-ups to unemployment benefits (hence the change in the fiscal stance shown above is lower). 

The second key reason is that most of what is being proposed should be thought of more as balance sheet support rather than money that will be spent in the economy. Take for instance the help for state and local governments, which makes up around 1/5 of the package. This money will plug the gaping hole left in government finances due to the collapse in tax receipts.

As such, it is more about preventing local government from having to make cuts to spending, rather than encouraging it to spend significantly more than at present. Similarly, the support for households is also more about replacing lost incomes than encouraging them to spend.

There is some evidence of a stimulatory effect in the consumption data, but this is a side effect rather than the main purpose – which is to ensure those negatively impacted by the pandemic are still able to meet their essential obligations (living costs and debt repayments). This is corroborated by survey data, as well as the fact that the savings rate has surged – and remains elevated.

While near-term fiscal largesse is geared towards providing relief, further out we do expect more traditional stimulus, in the form of massive planned investment in renewable energy and infrastructure, with this raising 2022 growth by around 1.9pp.

Given this, we expect the output gap to close over the next year and full employment to be reached in 2023. This should put some modest upward pressure on inflation over a 2-3 year horizon, but this should not be exaggerated given the modest price pressures that were seen when the economy saw similar conditions in 2018-2019. We therefore think US fiscal policy should lead to reflation rather than overheating. 

What happened to the eurozone fiscal stimulus? The picture for the eurozone in terms of the fiscal stance looks quite different from that of the US.

As shown in the chart below, following large-scale discretionary fiscal measures last year, the additional stimulus this year looks likely to be rather modest. At the sovereign level, last year’s measures are being extended – which looks to be very wise – but this simply leads to a rather neutral fiscal stance.

Additional stimulus will come mainly in the shape of the European Recovery and Resilience Facility (RRF), but that will only be rolled out in earnest later in the year, so the main effects will come from 2022 onwards. In addition, there are some substitution effects, with some of the RRF used to finance plans that were already in budgets at the government level. There are also large skews – stimulus in the periphery will be large, while it is modest in the core and semi-core.

Change in the eurozone fiscal stance, (+ = stimulus, % GDP)
Source: EC, ABN AMRO Group Economics

We expect rapid economic growth in the eurozone in the second half of the year as lockdowns are lifted. However, the additional boost from fiscal policy will be more limited, and as a result a large output gap will remain through our forecasting horizon. This points to subdued inflationary pressures in 2022-2023 after this year’s jump in inflation. So the story in the eurozone is not one of reflation, let alone overheating, but rather a recovery with low inflation.