Brexit, Trump and the populist revolt against globalization dominated talk in the hallways at the International Monetary Fund/World Bank Group Annual Meetings in Washington, D.C., where world central bank and government officials mingled with investors this past weekend. While fears about politics, populism and protectionism were ubiquitous, the economic worries that dominated the past several annual meetings have clearly abated:
- Emerging markets (EM), which topped the worry list at last year’s meetings, are widely seen as having stepped back from the brink. (My EM colleagues will follow up with their take on the key EM themes on the blog tomorrow.)
- Deflation risks, which had been a recurring theme ever since the global financial crisis, hardly came up at all.
- While economic growth is too low and everyone now seems to worship at the secular stagnation church, recession risks were judged to be contained.
- Despite lingering concerns about Europe (which dominated the 2010–2013 meetings) and some attention to the banking sector problems in Italy and Germany, the consensus view is that Europe’s economy and financial sector will continue to muddle through.
Policy shift: less monetary, more fiscal
Here’s the strongest macro conclusion I drew from everything I heard in D.C. Heightened worries about politics, populism and protectionism, together with diminished fears of deflation and recession, will likely lead to a very different policy mix in the advanced economies: less monetary, more fiscal.
Last November I argued that we are about to see “The End of Fiscal Obstruction” in the advanced economies. Since then, Japan has shifted from fiscal tightening to easing with its recent stimulus package, the new UK government is planning to end austerity and many other European governments, including Germany’s, are now focused on tax cuts and more assistance to those left behind by globalization. As one official put it to me in D.C., “The best defense against populism is … populism.” In short, expect the fight against inequality and for inclusion to become official policy in large parts of the advanced economies, almost irrespective of who wins the many upcoming elections.
Most central bankers would welcome the helping hand from fiscal policy, as it would make the exit from unconventional policies easier. But here’s the catch: While desirable from an economic point of view, the handover from monetary to fiscal policy is a highly delicate one because markets have been both sedated and seduced by the prospect of low rates for longer. If this mantra is called into question by growing expectations that central banks will take the foot off the accelerator as governments finally step up, the eerie calm in markets won’t last.
What to do?
Enter the Bank of Japan, which had been a pioneer of such unconventional policies as zero interest rates, quantitative easing (QE) and corporate and equity purchases long before other central banks. Now, the bank is pioneering yield curve targeting, which can be seen as a means to prevent a big sell-off in Japanese government bonds if and when the Japanese government were to engage in major fiscal stimulus. The European Central Bank and the Bank of England may need to extend similar invitations to governments to engage in fiscal expansion if they want to withdraw from QE and at the same time prevent a sharp rise in bond yields that could hurt financial conditions.
Joachim Fels is PIMCO’s global economic advisor and a regular contributor to the PIMCO Blog.