The global economy is about to get very interesting. US policymakers are embarking on a significant experiment that could redefine our understanding of the structural features of developed world economies. Slow growth, low productivity, sluggish wages and inflation — all characteristics we’ve come to accept as an unfortunate structural disposition — could give way to a more buoyant, dynamic economic landscape. The experiment combines two powerful ingredients: monetary and fiscal policy.
Let’s start with fiscal policy. President Biden recently passed a $1.9 trillion stimulus bill. This plan is extraordinary in four ways. First, its size: it is worth about 9 per cent of US GDP. Second, its speed. About 5 per cent of GDP will be doled out before the end of September. Third, its timing. The stimulus is being delivered when the economy is recovering rather than contracting. And finally, its nature. A large part of the stimulus is in the form of cheques in the post. For example, a family of five with a total income of $145,000 will receive a combined $7,000 in stimulus cheques.
Biden has further ambitions. He has set his sights on another bill to upgrade “human and physical capital”. While this package will partially be funded by higher taxes and could affect the economy more gradually, it represents an additional stimulus.
The fiscal stimulus adds fuel to what might already have been a strong recovery in private sector activity. Restrictions on the ability to spend last year, coupled with income support early in the pandemic, meant that households accumulated a sizeable pot of savings. By our estimates, excess or forced savings amounted to about 8 per cent of US GDP last year. Economists are divided over the extent to which this will be spent. Some say households will stay cautious and hold on to their savings pot. I’m not so sure. US consumers are generally not known for their thriftiness. After a year of enforced confinement, I think there’s a good chance they’ll be rushing to the shops and restaurants. Recent business surveys and credit card spending back up this idea. And the US won’t be the only beneficiary. Some of this demand will spill over to the rest of the world as US consumer spending sucks in global imports.
Other governments may also be tempted to follow suit. Finance ministers fear running persistently high deficits for fear of losing international investors’ confidence and seeing a run on their bonds and currency. But there is safety in numbers if everyone is working in tandem. Given austerity fatigue among the electorate, it’s arguably the politically more palatable option.
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Central banks are unlikely to put a damper on things. The Federal Reserve is trying new things, steadfast in its belief that inflation is extinct. Therefore the US economy can, and should, be run hot. Its ambition is driven by the need to make up for the earlier years of low inflation and achieve broader societal goals of full and inclusive employment.
And so, rather than lean against fiscal largesse, the largest developed-world central banks look set to support governments by holding down the interest rates at which governments can borrow. Despite expectations of a robust recovery, there is consensus that the Federal Reserve and European Central Bank will continue buying government bonds, at their current pace, for the rest of this year.
With interest rates kept low, there is one further catalyst to the experiment: credit growth. Commercial banks are, on the whole, well-capitalised. And, with pandemic loan losses coming in lower than expected, they are likely to regain their appetite to lend. Households may be willing borrowers. Not only are interest rates temptingly low, household balance sheets are in better shape than they have been for more than a decade. Based on the most recent data, US household debt has fallen from almost 100 per cent of GDP in 2008 to 78 per cent today.
Consider how different this is relative to the last expansion. One of the critical features of the previous cycle was the lengthy period of deleveraging by governments, commercial banks and households. Central banks made money cheap, but they had no partner to distribute it. Nor were many households and corporates willing to borrow. That is no longer the case.
This is when things start to get exciting. If demand booms, will there be a chain reaction? Could it spur investment? And, in turn, productivity? Lacklustre business investment was another feature of the last expansion, with the most commonly cited reason being uncertainty over demand. Business surveys in recent months already suggest that capital spending intentions are picking up.
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It’s possible the experiment will ultimately push up inflation. Supply might not keep pace with soaring demand, at least in the near term, when supply bottlenecks continue to be a problem. Labour markets could tighten quickly if the latest US jobs report is anything to go by, with almost a million jobs created in March alone. Any slack could disappear rapidly, and workers might demand higher pay to tempt them back, given more elevated levels of unemployment benefits. If wage growth does start to pick up, then any short-term spike in inflation caused by supply bottlenecks might not prove transitory.
It is possible — if not probable — we will discover that many of the features that plagued our economies during the last expansion were not structural. Instead, they may simply have been caused by the long cyclical drag of government, bank and household deleveraging.
Governments are now focused on “building back better”, central banks are seeking to run things hot and households are keen to make up for lost time. This experiment could throw up some fascinating results, not least much more robust growth and higher inflation than we have seen for some time.
Karen Ward is chief market strategist for Europe, Middle East and Africa at JP Morgan Asset Management
Patrick Hosking is away
