Virus is a catalyst for a fiscal reboot worldwide

Mike Dolan LONDON | Updated on March 08, 2020

A street vendor sells face masks outside the central railway station, after a coronavirus outbreak, in Milan, Italy on February 24, 2020.   -  REUTERS

Many investors are perplexed by the reluctance of governments to use near-zero borrowing costs to crank up investment spending to reboot growth, inflation and even fight climate change. The coronavirus shock may finally break the logjam.

The rapidly spreading virus threatens to bring global economic activity to a grinding halt. Central banks are reacting, but they do not have much room to support the economy. With inflation still dormant and falling, it is puzzling why governments don't embrace borrowing to both stimulate activity and invest in future infrastructure.

Mike Kelly, head of multi-asset investments at the $100 billion Pinebridge Investments, likens this government reluctance to a kid who freezes beneath the basketball hoop, as parents of both teams shout: “Shoot the ball, Johnny!”

For Kelly, the next move for governments is obvious, if not inevitable. He reckons Berlin, Washington and London will now have to use fiscal expansion in a way that goes far beyond remedial cash to fight the COVID-19 virus because targeted measures will not be enough.

“Whether you support it or not, it feels like a slow-moving dance to MMT,” said Kelly, referring to the Modern Monetary Theory, which argues that governments can borrow almost unlimited amounts of money without leading to inflation as long as it was in their own currency.

So far, fiscal policy responses are mostly specific to fighting the virus or offsetting the damage to worst-affected businesses. The United States has earmarked almost $8 billion additional funds, for example, and Italy - Europe's worst affected country - is spending as much.

White House economic adviser Larry Kudlow said on Friday it was too early to determine the magnitude of any slowdown. “We're not looking at big, expensive, macro cash rebates,” he told Fox Business Network on Friday.


There are some good reasons for trepidation by governments. Ramping up spending is potentially inflationary, and critics fear politics would prevent governments from unwinding spending quickly if inflation were to get out of hand.

Europe is also a different proposition than the United States, due to euro-area rules and Germany's dogged refusal to boost deficits amid fears of its rapidly ageing demographics. In the UK, the head of an influential think-tank, the Institute for Fiscal Studies, said the British government should not change budget rules to allow itself more borrowing.

But with subpar growth since the financial crisis already blamed for voter frustration and political disruption of recent years, another downturn now ups the ante. Some economists, including those at Nomura, say severe scenarios - such as a possible second wave of virus infections in China - could see global growth for 2020 fall to less than half of prior estimates.

The World Economic Forum cites studies estimating that flu pandemics will cause an annual average loss of 0.7% of world GDP, or about $570 billion, over the coming decades, which is in the same ballpark as unchecked global warming.


It is cheap for governments to borrow. The U.S. Treasury's 10-year borrowing rate plunged below 1% for the first time this week. The widest measure of global sovereign and company bond borrowing costs at similar maturities - the Bloomberg-Barclays Multiverse - fell to a record low of 1.2%.

Few in financial markets see rising inflation as the central problem for governments for years to come. The pricing of long-term bond markets now signals that central banks won't hit 2% inflation targets for decades. Ongoing reviews of the Fed and ECB's policy frameworks might even allow inflation to run hot for a period to mirror years of undershooting already seen.

Washington may already be heading toward bipartisan consensus on fiscal loosening. It's been embraced in China and Japan for many years. The virus scare may act as a catalyst in Europe, too.

Recent comments from German politicians show Chancellor Angela Merkel's conservatives are now split over whether Berlin should launch a fiscal stimulus package.

On Thursday, European Union officials said it is giving governments all the fiscal leeway they need to individually deal with the impact of the coronavirus and may decide on a more concerted stimulus if the economy severely suffers.

To policymakers, the basketball hoop should start to look less daunting by the day.


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Published on March 08, 2020
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