Taken too far, unfettered fiscal and monetary stimulus by governments and central banks could have far-reaching consequences
The results from the Georgia election runoffs in the U.S. have galvanized investors’ expectations of Blue Wave Biden administration, leading to bets on even more accommodative policies to help Americans through the ongoing COVID-19 pandemic crisis. But with fiscal taps opened to the fullest and interest rates near zero, there’s a hanging fear that the measures being taken will eventually leave the country saddled with enormous and crippling debt.
But according to Andy Kochar and David Stonehouse of AGF Investments, the consequences might not be that dire – depending on how far into the future you look.
In the company’s outlook report for 2021, the two wrote that the current state of the world can be reasonably regarded as a broadstrokes real-life application of Modern Monetary Theory (MMT), which asserts that governments that issue and control their own money need not worry about deficit spending, which they should pursue to achieve full employment and a reasonable level of inflation.
“[T]o be clear, the world is not full-on MMT (yet),” they said. “There has been no explicit endorsement from the Fed or other central banks; there has been no explicit capitulation of central bank independence. So far, we are seeing only the more practicable parts of MMT put into place.”
Kochar and Stonehouse to the current paradigm as “MMT Lite,” which has led governments to spend US$12 trillion – roughly 8.5% of global GDP – in direct relief and lending into the economy. That’s in contrast to the staggered and relatively delayed response governments mounted during the Global Financial Crisis, when the fiscal response concentrated on providing life support to the financial system and the monetary response was not synchronized across countries.
Citing the U.S. Congressional Budget Office, the two said the U.S. fiscal 2020 deficit is projected at roughly 15% of GDP, exceeding the levels seen during the Global Financial Crisis and the Second World War. Using AGF’s own research in conjunction with Bloomberg Data, they said the Fed’s quantitative easing is expected to own 27% of the U.S. government bond market by 2021.
Canada faces an even more sobering reality, as the fiscal 2020 deficit threatened to reach 20% of GDP while Bank of Canada ownership of the Canadian bond market is set to exceed 50% by year-end 2021.
The two said that rampant inflation and sharp devaluations in the U.S. dollar feared by investors are not likely to manifest in the near-to-medium term. They took the view that, as a base case, the greenback will remain rage bound as any negative impact will likely be countered by stronger economic growth, while some cyclical inflation could take place next year. Bond yields should creep up, they added, with a steepening of the yield curve.
“[T]here seems little reason to worry about rampant inflation or, for that matter, to anticipate runaway economic growth for years to come,” they said, pointing to secular issues such as technology trends, aging demographics, and massive debt levels all are likely to suppress inflation or runaway growth.
They cautioned, however, that another shock in the longer term could nudge policymakers into a more full-bodied embrace of MMT with such measures as the adoption of yield curve control. Negative nominal interest rates, they added, will inevitably prove unsustainable, forcing central bankers to cleanse their debt by inflating their respective economies out of debt.
“[M]onetary policymakers tend to overshoot their target,” the two said, suggesting a possibility of hyper-inflation. Turning off the fiscal taps won’t quite cut it, they added, as politicians would have even more economic power at their disposal.
“Will they be able to steer back to a more frugal course when they hit the guardrails of higher inflation? Their track record is not encouraging,” Kochar and Stonehouse said.
