Despite efforts over the past four years to tear down the underpinnings of the global economy, pandemic economics has reinforced that this is indeed a global economy. Every one of the major-currency economies suffered through a health crisis and negative economic growth last year, according to the most recent estimates.
The weighted-average decline in real gross domestic product last year among the 11 industrialized economies with free-floating exchange rates is expected to be 5.2%. Those losses will be followed by increases centered on an average of 4% growth for this year and 3.5% next year.
Moreover, the policy response by governments and central banks around the world has focused on the integration of fiscal and monetary policy to offset the impact of the pandemic and create the conditions for economic expansion.
It is not surprising that the United States has put forward fiscal aid that is roughly equal to 18% of GDP, compared with 20% of GDP in the U.K. and Canada. Should the Biden administration’s proposed $1.9 trillion mix of fiscal aid and stimulus be implemented, it would lift that figure to roughly 25%.
As a result of the deployment of fiscal firepower, conditions are ripe for a general reflation in growth.
In the United States, we expect a 5.4% rate of growth this year and 3.4% next year. The 10% contraction in the U.K. last year will result in a 4.8% rate of GDP growth this year and 7.5% in 2022. Canada will experience a 4.5% pace of growth in 2021 and a 4% increase in output next year.
The lessons of the financial crisis
The cost of fiscal and monetary policy errors during the financial crisis in 2008-2009 was steep. The long echo of fiscal fatigue and the austerity that followed resulted in a truncated global economy and reactionary populism around the globe. It is essential that those same mistakes are not made as economies move back into recovery later this year.
The reasonable question, then, is not whether government intervention is necessary, but rather how much is required to dampen excesses during an upswing or to promote sustainable growth in a downturn. Investors, firm managers and policymakers should prepare for an extended period of fiscal activity to return economies to pre-pandemic levels of output and employment.
With accommodative monetary policies quickly adopted when the coronavirus broke out, one half of the policy prescription is already in place.
Liquidity injections in the money markets were able to keep commerce going, while central bank purchases of longer-term securities helped to pressure interest rates lower along the yield curve. In the United States, 1.0% yields on the 30-year Treasury are enabling the government to borrow at negative real interest rates, with that debt repaid in cheaper (inflation-adjusted) dollars.
While the Federal Reserve is unlikely to adopt a negative policy rate – as is the case in Japan and the eurozone – the fixed-income markets have already made the adjustment, pushing real policy rates below the zero lower bounds.
At the same time, central bank purchases of longer-term securities – in concert with market expectations of low levels of economic growth and the threat of deflation — have pressured bond yields lower along the yield curve.
That pressure has resulted in negative real interest rates in Canada out to five years’ maturity, in the United States and U.K. out to 10 years’ maturity, and in Germany out to 30 years’ maturity.
That leaves the dilemma of determining the appropriate size and focus of the fiscal policy response. This downturn offers particularly difficult and expensive circumstances. Not only are governments left to bear the cost of protecting the public from a health crisis, but the crisis itself has also resulted in significant dislocations of labor and income streams that are bound to outlast the distribution of vaccines.
Consider that an hour of lost labor can never be recovered. If you’re out of work for an entire year, then it would be impossible to recover the lost 40 hours per week by simply working 80 hours per week in the following year. The same analogy goes for idle capital, though a vacant storefront does not carry the same human consequences.
The global economy has clearly embarked upon a great reflation of economies led by the integration of fiscal and monetary policies, with the former taking the lead and the latter a complement with the big bazooka of fiscal firepower.
This, in many respects, represents a revolution in policymaking that has dominated the past four decades in the advanced industrial world in general and the United States and U.K. in particular where macroeconomic stability policy has been primarily outsourced to central banks.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.