Governments to struggle unwinding ‘unorthodox’ policies

ING Economics’ regional head of research, Asia Pacific, Robert Carnell, has published an analysis of the long-term implications of fiscal action taken by governments to curb the economic impact of the COVID-19 pandemic.

Mr Carnell noted the “unleashing of fiscal and monetary firepower” that has taken place over the past month, which, he said, “overshadows that seen during the global financial crisis”.

The ING economist pointed to unprecedented rate cuts from central banks, including the Reserve Bank of Australia (RBA), but stressed that such moves pale in comparison to fiscal stimulus injected by governments.

“Some central banks have cut rates to levels never previously reached. Others have reverted to quantitative easing. Still others have started unorthodox measures for the first time ever. This monetary firepower is nothing though compared to the weight of fiscal stimulus measures,” he said.

“These stimulus packages are growing by the day but seem to be converging on rates equalling or in some cases, exceeding 10 per cent of GDP.

“Fiscal deficits for these countries, as a proportion of GDP, will be much larger still, as tax revenues collapse along with the GDP denominator.”

Mr Carnell said unprecedented levels of government spending could result in deficits of approximately 25 per cent of GDP for some major economies.

“But despite huge existing piles of debt, governments and central banks know they must spend now, and worry about the consequences later, or risk losing a huge chunk of their normally productive economies, for ever,” he added.

Mr Carnell warned that governments may face significant challenges in reducing the economy’s dependence on such fiscal support once the current coronavirus crisis abates.

“[The] problem with a 10 per cent stimulus packages this year is what to do the following year?” he continued.

“Failure to replicate means a switch from fiscal boost to fiscal drag. And like any drug, going ‘cold turkey’ after a massive fiscal binge will rarely end happily. 

“So, governments tend to keep spending just to stay out of technical recession.”

“It doesn’t take too many years of this to end up like Japan, and debt-to-GDP ratios in excess of 300 per cent – with no credible possibility of ever conventionally returning to sub-100 per cent levels.”

Mr Carnell suggested monetary financing of deficits as a means to easing the debt hangover.

“In its most innocuous form, this could entail a nation’s central bank converting its direct holdings of government securities purchased through quantitative easing, into non-interest-bearing perpetual bonds,” he said.

“This is almost the same as saying that the debt has been annulled, but avoids the central bank having to write off its capital and perform yet another monetary conjuring trick of recapitalising itself with printed money.

“It is though, without the same fanfare, equivalent to what is otherwise called ‘helicopter money’. Such policies had already been considered a likely endgame for economies such as Japan. Now, most economies will find themselves in a similar position.

He concluded: “So, if not now, when?”

The Australian government has announced a raft of measures over the past month in response to the weakening domestic economy.

The government’s actions have included measures to stimulate the flow of credit to households and businesses and provide income support for low-income households. 

When including financial sector assistance from the Reserve Bank of Australia, the government’s stimulus support totals over $320 billion – equivalent to over 16 per cent of GDP.

[Related: RBA urged to expand QE program]