IN FOCUS6-8 min read

Central banks are low on firepower – so what else could rev up the global economy?

With global interest rates already low or negative, central banks are turning to national governments to stimulate growth. But can they afford to?



Janet Mui
Global Economist, Cazenove Capital

Slowing global growth and lingering political uncertainty prompted major central banks around the globe to cut policy rates in 2019. However, developed markets' central banks are running out of monetary firepower. Some, such as the European Central Bank and the Bank of Japan, are also getting more mindful about the undesirable side-effect of ultra-low or negative interest rates.

With trade tensions and political uncertainty the current key risks to the global economy, there appears to be little that central banks can do. Fiscal policy – which is where national governments provide a domestic economic boost in the form of increased spending or a cut in taxation – looks like the best economic treatment available.

There are increasing calls for these forms of “fiscal expansion”, but the economic outlook might have to get worse before individual nations, many of which have entrenched domestic economic difficulties, are prepared to act. The likelihood of such action differs by country, and in the following pages we explore which nations have the need, space and political will to implement fiscal stimulus in 2020.

Fiscal boost in the UK

Some form of fiscal boost is more of a certainty in the UK than elsewhere, as spending pledges were key planks of both major political parties’ election campaigns. In its manifesto, the Conservative Party promised not to raise income tax, national insurance contributions and VAT for five years. Alongside this it made a range of smaller spending promises. Key measures included a rise in the national insurance contributions threshold to £9,500 in April 2020.

Even before the election pledges, fiscal expansion worth £65 billion is already under way as a result of the 2019 Spending Review. Due to the relaxation in spending rules that Chancellor Sajid Javid announced in November 2019, which is based on borrowing up to 3% of GDP to finance investment, there is around £150bn in fiscal space over the next four years cumulatively.

With ongoing Brexit uncertainty likely to limit a strong rebound in business investment through 2020, fiscal policy could be an increasingly important domestic factor supporting UK growth this year.

Mixed picture in the eurozone

In the eurozone growth slowed significantly in 2019 due to worsening external demand. Arguably this is the region that needs fiscal spending the most.

With negative interest rates and record low borrowing costs, the European Central Bank has created a favourable environment for fiscal spending and has repeatedly urged national governments to take on the baton of providing stimulus. Indeed, according to the 2020 draft budget submissions to the European Commission, both France and Italy have plans to spend a little more thanks to downward revisions of interest payments. However, any ambitious stimulus which results in "fiscal slippage" – or a sharp deterioration in a country's financial position – is unlikely to be approved by the European Commission.

Within the eurozone individual countries face unique financial and cultural challenges. The region as a whole has to rely on individual countries’ ability and willingness to spend. According to the fiscal rules enshrined in the Stability and Growth Pact, only a handful of countries – such as Germany and the Netherlands, which are running a budget surplus – have substantial room to spend. Germany has by far the largest fiscal room, but it remains committed to the “Black Zero” (a balanced budget), meaning the political bar to spending is high. This is because German governments traditionally take a decades-long view of public finance requirements, including factors such as demographics.

The German government has recently announced a new climate change fund worth €45 billion, but this will be funded via higher taxes and by selling CO2 certificates. Even against a more positive backdrop of low unemployment and stabilisation in manufacturing activity, we think it unlikely that Germany will deviate from its conservative fiscal stance in 2020.

The US... and China

In the US, the Bipartisan Budget Act of 2019 set the spending caps through fiscal year 2021, so there is not much uncertainty in terms of available fiscal support – at least through 2020. Unless the US goes into a recession, which we do not expect, the room for further fiscal stimulus is limited.

Tax cuts and spending plans implemented since 2017, in line with President Trump’s election pledge, have already caused the US budget deficit to widen from -2.9% at the end of 2016 to -4.7% by the end of 2019.

In China, government spending has historically played an important role. The scale of the post-crisis Chinese stimulus was so great it impacted significantly on global growth. Most memorable was the four trillion yuan spree in 2009 (worth 11.5% of that year's GDP), unfortunately leaving behind a bloated and heavily-indebted state sector. While a repeat of similar stimulus is highly unlikely, spending continued to feature in the latest round of policy easing amid US-China trade tensions. This included two trillion yuan of tax cuts (2% of GDP) and local government bond issuance to support infrastructure investment.

However, with mounting debts raising financial stability concerns in China, there are clear spending limits. We believe a “drip-feed” of mixed monetary and fiscal stimulus will be implemented throughout 2020 to help cushion the negative economic effects of trade tensions. Meanwhile, structural reforms to unleash domestic demand and move the economy up the industrial value chain, along with the liberalisation of financial markets, will be viewed as China's most important drivers of sustainable growth.

Room for manoeuvre: which countries can spend?

There is some fiscal space in most advanced economies


Source: Refinitiv Datastream, Schroders Economics Group, IMF. July 2019

What this chart shows

The IMF calculates “fiscal space” to determine whether governments can raise spending or lower taxes without endangering market access and putting debt sustainability at risk. This takes account of existing and likely debt levels as well as funding costs (interest payments) and longer term pressures such as ageing populations. Based on data for 2016-17 the IMF finds that, broadly, the advanced economies have room to spend – with only Italy and France having “limited” space.


Janet Mui
Global Economist, Cazenove Capital


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