Fiscal policy to the rescue?

The period of weak global economic growth still seems set to continue, even though a slight upturn in activity in 2017 is expected. The sources of fragility that contribute to this situation are numerous.

In developed economies, the improvement observed in 2015 was short-lived and there is unlikely to be a significant increase in growth in 2017. The Brexit shock is widely expected to have a negative impact, while the positive effect of the decline in oil prices on domestic demand, especially in Europe, is now behind us. Instead, the cyclical rebound is expected to come mainly from emerging countries, where there have been further signs of recovery since the summer, although they remain fragile.

In developed economies, the improvement observed in 2015 was short-lived and there is unlikely to be a significant increase in growth in 2017. The Brexit shock is widely expected to have a negative impact, while the positive effect of the decline in oil prices on domestic demand, especially in Europe, is now behind us. Instead, the cyclical rebound is expected to come mainly from emerging countries, where there have been further signs of recovery since the summer, although they remain fragile.

Overall, while global growth is set to firm up in 2017, it is expected to remain weak. The surplus production capacities generated by years of economic under-performance are therefore unlikely to be wiped out anytime soon, and inflation is not set to rapidly accelerate. As a consequence, the central banks, and the European Central Bank in particular, are likely to remain under pressure to keep the ultra-accommodative monetary conditions. However, these central banks have already implemented large-scale asset purchase programmes, funded through money creation (often called Quantative Easing) as well as negative interest rates. As such, they seem to have largely used up the tools available to them.

In light of this, there have been increased calls for a coordinated fiscal stimulus from major international institutions like the International Monetary Fund, which could eventually translate into a relaxation of the fiscal stance. Indeed, several countries have recently eased their policies in this area. In France, additional spending increases and tax cuts have been announced and the government’s target of cutting the public deficit below 3 % of GDP in 2017 now seems difficult to achieve. The Japanese government has also decided upon a new fiscal stimulus package this summer.

That said, between now and 2017, global fiscal stimulus is likely to remain limited, or even non-existent. Indeed, the IMF forecasts that developed countries will, on average, run a neutral fiscal policy, while emerging countries will tighten theirs up.

Several factors prevent the implementation of a broad global fiscal stimulus. Firstly, the domestic political context tends to paralyse fiscal policy in some countries. Secondly, the current fiscal situation leaves little room for further increases in public debt: in developed countries, public debt is running at 106% of GDP in 2015, compared to 72% in 2007. Among emerging countries, oil producing countries are being forced to improve their public finances, following the fall in revenues. Meanwhile, countries with fiscal room to maneuver (such as Germany, Sweden, Australia or Korea) are reluctant to use it in the short term.

Consequently, significant fiscal support for the global economy appears unlikely to happen soon, which reinforces our forecast of little acceleration in growth and inflation in 2017. This suggests that the major central banks are likely to prolong their ultra-easy monetary policies, thus maintaining interest rates at very low levels.