Whatever happened to fiscal policy?

One of the features of the credit crunch era has been the way that monetary policy has been taken to extremes. Indeed The Eagles were again ahead of events.

Take it to the limit
Take it to the limit
Take it to the limit one more time

We saw interest-rate cuts followed by the spread of Quantitative Easing and other extraordinary measures. Then we saw interest-rates especially in and around the Euro area cut to below zero and into the icy cold world of below zero or negative interest-rates. In the last few days we have got more hints in this area from the European Central Bank. At its last meeting its President Mario Draghi told us this and the emphasis is mine.

Let me say that rates will stay low, very low, for a long period of time, and well past the horizon of our purchases. From today’s perspective, and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further

Yet on Friday in La Repubblica Peter Praet of the ECB told us this.

In the Introductory Statement we said very clearly that we “expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases.

That is a complete U-Turn and is an example of the ECB abandoning a stated position which has become very common on the Lower Bound for interest-rates. Governor Kuroda in Japan did so in only one day recently and of course Bank of England Governor Mark Carney stated it was at 0.5% whereas now he only has to look across La Manche to see one of -0.4%. Of course the situation is also one where Open Mouth Operations have been added to the list of monetary activism.

What about fiscal policy?

With the unemployment problem that the Euro area faces (10.3%) you might think that fiscal policy might have been applied. Even more so when you note the youth unemployment rate of 22%. Well it would appear that the ECB is moving in that direction as well. Here is Benoit Coeure in Paris today and this comes after a fair bit of triumphialism about ECB monetary policy.

But the ECB cannot single-handedly create the conditions for a sustainable recovery in growth. This requires a concerted effort in terms of economic and fiscal policies.

Such as Benoit?

It’s true that there is limited room for manoeuvre in terms of using fiscal policy to support growth, and the fiscal rules cannot be stretched to the point where they would lose all their credibility. But while some countries have such margins under the Stability and Growth Pact (which they are already partly using to support refugees), all countries can make their tax structures more favourable to growth and redirect public spending towards investment, research and education.

There is a clear guide towards Germany there which I shall return to in a moment. But let me address the “credibility” of the “Stability and Growth Pact” which is an attempt to distract from the fact that it has none because it was ignored with both France and Germany cruising through its rules. There is a possible context here as the Euro area may have set its stall against fiscal policy because it had overdosed on it. To be more specific there is Italy and Portugal which have ever growing national debts ( a ratio to GDP of around 130%) but very little economic growth to show for it.

The Monthly Bulletin joins in

Today’s monthly bulletin joins the growing chorus.

Low levels of public investment, if maintained over a prolonged period, may lead to a deterioration of public capital and diminish longer-term output.

The ECB technocrats were no doubt particularly pleased that they can slap themselves on the back along the way.

In this debate it is argued that public investment would be particularly effective in an environment of low borrowing costs for governments, in which monetary policy interest rates stand at around zero.

Well done us! Actually there has been an easing of fiscal policy here as lower borrowing costs have ceteris paribus allowed governments to spend more elsewhere. Also there is a technocratic element here as it pushes the case for investment. We see this in the UK but “investment” is something of a mythical beast which is hard to pin down. After all past UK-French investment produced Concorde which looked stunningly beautiful as it flew over Battersea set against a blue sky but was an economic failure as the Boeing 747 marched on. Actually later on the ECB admits this.

the distinction between investment and other government expenditure is not always clear

There are of course other problems for the ECB.

In particular, recent years have seen the ratio decline in countries that had to undergo sizeable fiscal adjustment owing to market pressure.

Awkward to say the least as it is the countries which have the highest unemployment rates who have been forced to undergo Euro area austerity. Even more awkward when you consider that the ECB has been a cheerleader for this, remember the letter to the government of Italy and its role in the Troika in Greece.

The fiscal positions of many EU countries remain precarious, however, and the provisions of the Stability and Growth Pact call for further fiscal consolidation in many of them.

You do not need to take my word for it as we have official confirmation in the way that the Troika switched names to institutions in the same way that the leaking Windscale nuclear reprocessing plant became the leak-free Sellafield!

Rather like the god Janus the ECB is looking both ways on this issue as it seems to want further fiscal consolidation in the countries that would most benefit from fiscal policy but also to have it.

An increase in public investment has positive demand effects and can contribute to the economy’s potential output by increasing the stock of public capital.

Having your cake and eating it!


As we so frequently find Germany is at the heart of this problem. From Destatis.

Net lending of general government amounted to roughly 19.4 billion euros in 2015 according to updated results of the Federal Statistical Office (Destatis). In absolute terms, this was the highest surplus achieved by general government since German reunification. When measured as a percentage of gross domestic product at current prices (3,025.9 billion euros), the Maastricht ratio of general government was +0.6%.

Yes you did read that right after having a budget or fiscal deficit of 4.2% of GDP in 2010 Germany quite quickly headed for a balanced budget and in the last couple of years has run a surplus.Presumably the negative bond yields it has will continue the trend in 2016. So the “engine” of the Euro area and indeed European economy has decided to apply a literal form of austerity. This poses a problem as with its trade surpluses the economy which should be running a fiscal deficit in the Euro area is Germany which has done exactly the reverse. Whilst Germany for its own ends might consider a balanced budget to be a good idea the deficit nations badly need Germany to run a deficit in the hope that it will bring them extra business. If you like a quid pro quo for Germany receiving a much lower exchange rate.


There is much to consider here as the Euro area did apply fiscal policy but in the opposite direction to what it now appears to be cheerleading for! Not only were places like Greece Portugal and Italy put under a lot of pressure but Germany decided to do so as well. The ECB found itself having to take over much of economic policy as the political establishment looked the other way. Monetary policy became the only game in town and led us to negative interest-rates and yields a plenty.

Let me now widen the issue of fiscal policy to the UK. We have gone through a few days of a omnishambles in the UK on this front where an austerity effort has collapsed quickly. If so are we at a boundary of sorts? Let me throw in this from the Institute of Fiscal Studies.

In the longer term the public finances are kept on track only by adding yet another year of planned austerity on the spending side.

Not jam but pain tomorrow. We seem to be hitting trouble at a level of just below 4% of GDP per year as a fiscal deficit. A while ago we discussed that announced GDP growth of 2% per annum may be the new zero is a fiscal deficit of 4% per annum like that?

If we widen the geographical focus we see Japan grappling with this issue. It has an annual fiscal deficit of 6% of GDP and yet when it tried to do something about it via a consumption tax rise the economic effects were of very bad indigestion. Is that stimulus due to its size or austerity as it tries to shrink it? However you spin it it means that by contrast the Euro area overall has been very austere.

One area where there is clear inflation is in policy U-Turns which no doubt is an influence on this below from Bloomberg.




22 thoughts on “Whatever happened to fiscal policy?

  1. Hi Shaun

    You can understand this to a degree. If the deficit exceeds GDP growth then the debt /gdp ratio will increase leaving a higher stock of debt to be refinanced in the future at potentially higher interest rates.

    If you look at the situation both here and in Europe the economic cycle and the operation of the automatic stabilisers is going to add to the stockpile of debt and produce an increasing debt overhang which is inimical to future growth. This issue is compounded by structural factors which are driving deficits higher, most notably demographics. Add to this languishing productivity (in the UK certainly) and you do not have a very optimistic outlook, despite what the politicians would have you believe.

    There surely has to be a limit to the debt/gdp ratio beyond which it must be difficult to refinance at an interest rate which will not tank the economy and Japan seems to be the poster child for that.

    On that basis the concentration on monetary policy is perhaps understandable.

    • Hi Bob J

      Perhaps but taking monetary policy to the limit has not done Japan much good. In spite of the size of the national debt it is struggling to get its fiscal deficit down which is related to low economic growth and like a record it keeps spinning and playing. The ten-year yield is now -0.1% and they are saying this.

      BOJ’s Nakaso Says It Is Technically Possible To Go Further Into Negative Territory With Rates”

      Yep the same negative rates which they ruled out only a fortnight ago.

      As we have discussed many times on here such sustained negative interest-rates will collapse any business models that are not short-term and the saga starts all over again.

  2. Excellent article. The conclusion of the ECB’s musings seems to be for Germany to use its cash but for the investment to take place in Southern Europe where employment and economic activity need a boost. The probloem with ‘investing’ in Spain, for example, is what is left to build? They’re giving away airports built with our taxes because no one wants to use them and their roads and railways are already better than ours.

  3. Great column as usual Shaun, and thank you very much for your earlier comment on Canada’s debt-to-GDP ratio. Your column comes very timely here as tomorrow is budget day in Canada. Some Canadian economists, like McGill University’s Chris Ragan, have also been making the argument that too much has been expected of monetary policy and too little of fiscal policy in stimulating growth and employment, and to some degree they are surely right. Although Justin Trudeau’s party assailed Stephen Harper for running eight consecutive deficits while he was in office (bizarrely one of PM Trudeau’s junior economic ministers was still making this claim on TV even though last September audited estimates showed that the count stopped at six!) the fact is the Conservatives made a lot of cuts in federal spending and they really did bite. If you read my RPI CPI User Group comment on ferry services, it would be hard to confirm if ferry transport is a declining industry in Canada, as I conjectured, since the Harper government scrapped the entire maritime transport statistics program. The same was true of the truck transport statistics, although a Canadian is more likely to be a trucker than a lumberjack or anything else.

    • Hi Andrew

      Thanks and I will take a look tomorrow. As to your reply I am intrigued by the scrapping of some statistics in Canada especially ones which as you say look valuable. I was involved in some online debates on statistics today and pointed out that the UK ONS has been hurt by some budget cuts. Is the same true of Statistics Canada?

      • Shaun, thank you for your interest. Here is a link to a Globe & Mail article on the subject from two years ago:
        I can speak to other cuts that were made. There used to be a lot of special surveys of farmers on their input costs, including one on hired farm labour, used to support the farm input price index, equivalent to the UK’s input agricultural price index. These are all gone now. Surveys of farm equipment suppliers were also dropped. (Some of these cuts preceded the Harper government taking office.) When I was still working at StatCan, I helped re-establish the mortgage interest index using data from the Farm Credit Corporation. Otherwise the FIPI is really close to being a proxy price index.
        One of the cuts that for some reason seems to have fallen under the radar is the cancellation of the low-income cut-offs (LICOs). These were relative measures of low income derived from the household budget surveys. However, when low-income thresholds were based on a single budget year and price-adjusted using CPIs they were much like absolute measures, and did provide an answer to the question: “Is the number of low-income households rising or falling in Canada?”

  4. hello Shaun ,

    so theres no good business prospects anymore ? really ?

    of course Powa !

    thats explains it all…… prime British Management at its best

    if in government he’d get a knighthood like Merve !


    • Hi Forbin

      In Europe the main investment scheme is the Juncker Plan which he drew up on the back of a napkin. What could go wrong…?

      I am sure that there are plenty of good business prospects the problem is the people likely to be trying to find them…..

  5. Hi Shaun,
    Great blog as usual, but may I be permitted to take a different angle on how the world works.
    While you consistently point out the inconsistencies/U-turns/open mouth operations/limits to the use of instruments such as QE/lower interest rates, the fact is that:
    1. The elite have managed to get the mainstream media to accept/ignore all of the above. There is hardly a blink at the increase, by 20 Billion Euros a month of QE, for example;
    2. The elite continue to lead rather agreeable lives at our expense;
    3. The elite are successfully kicking the (very battered) can down the road, such that they will not be blamed when the proverbial hits the plan.
    The fact that they are clueless as to how to operate and may end up trashing the whole of the western economies is a petty detail when compared to the huge advantages in 1-3 above.
    I apologise for my cynicism, but what else explains their behaviour?

    • Hi James

      I don’t necessarily disagree as the Pet Shop Boys question always gets the same answer from our establishment.

      “And which do you choose, a hard or soft option?”

      Even if that can was made from titanium it would be showing some scars from all the kicks it gets.

  6. Hi Shaun.

    Off topic but I see that this month’s Private Eye includes a less-than-complimentary look at Battersea Park and Formula E, a subject that I know is close to your heart, and indeed to your home.

  7. take two

    Whatever happened to fiscal policy?

    nothing at all – the Plan is working and we’ll be the world of Dune very very soon


  8. Hi Shaun
    Germany had a problem of integrating the east on unification. They decided to depress the western workers to help equalise the economy. The elite started to like the effects, they got richer quicker, inequality between rich and poor grew. They encouraged this effect in the years after the euro introduction. They exported their ‘national savings’ via their commercial banks to the rest of the world, in particular to southern europe, to encourage sales of the stuff they made.
    The overall effect has been to enrich to German elite and depress the wealth of their workers and other nations in the EZ.
    Only two things will recover this situation. Right-off of debts held by other nations/banks by their banks and redistribution of wealth inside Germany via substantial tax cuts and wage increases.
    Chance of this happening? About the same as the odds on Leicester winning the premiership before the start of the season, so maybe pigs can fly!

  9. Yes Shaun, what fiscal policy? We do try and patch the roads, London gets some prestigious Investment ( crossrail etc) so that the city can believe its a global player. But essentially for the rest of the uk its a 1950s wasteland. Fat chance of building a powerstation or even a railway. It started to go wrong with PPP, you dont hear much about that anymore, when the taxpayer is still getting “raped” for under spec schools and hospitals.

    We should be balancing a budget and having 3-6% over for new investment. The UK probably needs to default for a clean sheet. Bring on the EU vote, our best chance in a long time.

    • Hi Paul C

      We can take a power station down or at least most of it as when I cycle past last week Battersea Power Station only had one chimney left. You are right about infrastructure as if we stick to my local area (SW London) it always lacked the tube but the years and promises all went by and something has only happened in my view because of the embassies going to Nine Elms. Rather amusingly the repeated episodes of Yes Minister are as fresh as ever.The explanation of why there were 2 good motorways to Oxford..

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