Governments may opt for more quantitative easing to prevent global inflation from turning into a recession, writes Cormac Lucey
Speaking about the Republic’s budgetary position in 1979, Charles Haughey famously declared that “as a community, we are living beyond our means”. But his remarks might just as well be applied today to Western world democracies.
An article in a June issue of
The Economist proclaimed that “Fiscal policy in the rich world is mind-bogglingly reckless”. Global fiscal policy is unsuited to today’s economic circumstances. “High inflation and low unemployment mean the world needs tight policy, not loose,” it said.
Last month, the Department of Finance’s chief economist indicated that between 2019–2070, annual age-related expenditure is projected to increase from 21.4 to 31.5 percent of Irish national output. With a projected 2023 modified gross national income of €284 billion this year, that rise would cost €28.4 billion today. That’s over €10,000 annually for every person working, more than the budgetary damage done by the financial crash 15 years ago and roughly equal to one-third of total budgeted tax revenues this year.
The situation in the UK isn’t much better.
A report on “Fiscal Risks and Sustainability” from the Office for Budget Responsibility in July, projected an increase in primary spending between 2022–23 and 2072–73 of 8.6 percent of UK GDP. That’s equivalent to roughly £2.2 trillion in terms of today’s GDP, or around £6,000 annually per person working.
Faced with inexorable spending pressures on one hand and political resistance to tax rises on the other, there is a structural risk that our political leaders will opt for greater borrowing as the way out.
The USA may be the forerunner in this regard.
It began running enormous budget deficits under President Trump even though the US economy was operating at near full capacity. It has continued this practice under President Biden. There has been no discernible political cost to be paid by either administration. And, as the issuer of the world’s largest reserve currency, it has seen precious little economic cost so far.
Fiscal dominance is shorthand for the fiscal needs of the central government dominating monetary policy set by central banks and occurs when central banks create fresh money (via quantitative easing) to prop up the prices of government debt securities and , thereby, contain the consequent interest rates.
Between 2009–2021, the share of their government’s issued debt held by central banks grew by about 15 percent in the USA and around 30 percent in the UK and the Eurozone. In essence, central banks were able to do something inflationary (create a lot of fresh money) because external circumstances were already very deflationary.
A justification can always be found: economies must be sustained through the financial crisis; we must not let a pandemic morph into a depression. The political cost was negligible. We can, therefore, expect more of the same in the future when fiscal push comes to monetary shove.
The constraint on fiscal dominance will not be rules or laws governing what is right or wrong but expedience: what can policymakers get away with?
The practical constraints will be financial market reactions and any inflationary effects of monetary loosening. But there may not be any noticeable market reaction: the Bank of Japan owns an estimated 45 percent of all Japanese government debt without any allergic market reaction.
The key question is whether inflationary pressures are stoked by aggressive fiscal dominance. The return of inflation explains why monetary restriction has replaced monetary exuberance.
But once inflation is out of the way, expect fiscal dominance (and more money-printing) to resume. That would be bullish for real assets (such as property and commodities) and bearish for paper assets.
Cormac Lucey is an economic commentator and lecturer at Chartered Accountants Ireland
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