Fra BNP Paribas:
Big picture: Through the fiscal looking glass The inability of super-soft monetary policy to prop up global economic expansion in the years after the global financial crisis suggests that fiscal relaxation may have been a more effective way of bolstering growth.
The same is true now. However, with a few exceptions, we do not expect budgetary policy to be loosened much next year, either in the developed or developing countries. Grappling with a major deterioration in their terms of trade, commodity exporters – most notably large emerging-market economies, such as Brazil and Russia – will actually need to cut back spending to maintain budget stability and prevent an unsustainable rise in public debt. Consequently, fiscal policy is unlikely to lend much support to global growth in 2017 either.
The eurozone’s still fragile economic recovery and the market’s perception that monetary policy may be becoming less effective at boosting growth and inflation are keeping the pressure on other policy areas to step in and dig the economy out.
The European Commission’s recent decision not to levy fines on Spain and Portugal for their lack of fiscal rectitude is a reflection of increasing concern over EU-wide economic growth, as well as the testing economic and political environment, especially after the UK’s vote to leave the EU. European decision makers are unlikely to embark on significant cuts in fiscal spending, so as not to jeopardise the tentative economic recovery and to amplify the positive impulses of loose monetary policy, we believe.
That said, however, we do not expect 2016’s fiscal expansion – of around 0.5pp in cyclically adjusted primary budget-balance terms, we estimate – to be repeated either. Germany made a significant contribution to the fiscal loosening this year, driven in party by refugee crisis-related spending, but public-consumption growth is seen slowing somewhat in 2017.
Countries including Spain, where a government has yet to be formed after two inconclusive elections, and Italy, in contrast, are likely to overshoot their budget-deficit targets. In 2017, the potential for more German fiscal easing is limited in light of the government’s stated aim of balancing the budget and little domestic pressure for action, as the unemployment rate is low and wage growth is solid.
Even next year’s general election is unlikely to spur budgetary generosity. Most of the other eurozone countries, meanwhile, have already used up any fiscal room for manoeuvre they had under the rules of the EU’s fiscal compact. Overall, then, we expect only a slight loosening of the eurozone structural budget balance next year. Of course, there is a risk that we may see more easing than we expect.
The challenging political and economic environment could prompt less austerity than is currently pencilled in, making the political backdrop more conducive to reform and fiscal austerity in the future – though this is by no means guaranteed. Ahead of the Brexit referendum, the UK government’s target was to eliminate the budget deficit by 2020. Its plan was quite aggressive, requiring fiscal tightening in the region of 1% of GDP per year.
In the wake of the UK’s vote to leave the EU, however, Prime Minister Teresa May has confirmed that the government will no longer aim to balance the books in that timeframe. At a minimum, this will involve far less tightening than before. Some within the government may push for an outright loosening, but the plan is so far unclear. The government’s new fiscal strategy will not be unveiled until the Autumn Statement in November.
The US federal government’s fiscal deficits have shrunk dramatically since the financial crisis, thanks to expiring fiscal stimulus and better economic growth. All in all, the federal deficit has fallen from a peak of around 9.8% of GDP in 2008 to just 2.5% of GDP in 2015 and is now in line in line with its 20-year pre-recession average. While we expect the deficit to hover around 3.0% in the near future, longer-term commitments imply a widening over time. Presidential candidates Hillary Clinton and Donald Trump have distinctly different agendas, which could lead to very different fiscal outcomes.
