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Washington’s Business

Will fiscal policy spur growth as monetary policy reaches its limits?

GLOBAL FINANCIAL MARKETS have faced quite a bit of uncertainty recently. On the international front, China's slowing economic growth and currency devaluation have been at the epicenter. On the domestic front, investors are dealing with choppy economic signals and changing expectations of how quickly the Federal Reserve may continue to normalize interest rates. Underlying this is a rising concern that monetary policy has reached its limit, especially if the U.S. economy slows. Therefore, all eyes are turning to the potential for fiscal policy to stimulate U.S. and global growth.

The limits of monetary policy
Since the financial crisis of 2008–2009, the Fed has used both conventional and unconventional means to stimulate an economic recovery, such as lowering interest rates to nearly zero and employing multiple rounds of quantitative easing (QE), which involves purchasing government and other market securities to keep interest rates low. These methods have worked. Since 2010 more than 10 million jobs have been created in the U.S., and gross domestic product (GDP) growth has averaged more than 2% annually. However, sufficient growth in inflation and wages is not yet fully reflected in the recovery. Fed officials have admitted there is little more they can do to address further economic weakness and have made a case that fiscal policy will be required to carry the recovery forward. Economists and investors are shifting their focus from money supply to legislative proposals and international accords.

The end of austerity (for now)
In the U.S., the age of government austerity appears to be over, at least in the near term. After impeding growth for several years, government spending has now been a positive contributor to U.S. GDP growth for five consecutive quarters, via contributions from state and local governments. Defense spending had been a drag, falling for four consecutive years, but is likely to rise in fiscal year 2016, according to Strategas Research Partners.


In October, Congress voted to raise the debt limit through 2017, removing the risk of a Treasury market default. Shortly thereafter, President Obama signed the deal, which allows the Treasury to borrow roughly $1.5 trillion, bringing the national debt to nearly $20 trillion. There is a growing sense that Congress is moving away from the brinkmanship of the past several years and toward compromise, which reduces near-term political uncertainty. Furthermore, it removes a major obstacle for the Fed to continue raising rates and normalizing monetary policy.


A significant global trade deal
The Trans-Pacific Partnership (TPP), a free trade agreement negotiated by 12 countries, is another example of fiscal policy that can make a difference by re-energizing growth in global trade. On Oct. 5, 2015, the U.S., Japan and 10 other Pacific Rim countries within the TPP completed nearly a decade of negotiations on this landmark trade agreement. The agreement is expected to create more attractive trade conditions for U.S. farmers, ranchers and manufacturers.

The Trans-Pacific Partnership trade agreement removes more than 18,000 different taxes on Made in America exports.

The agreement removes more than 18,000 different taxes on Made in America exports, according to the White House. For example, in its current form the TPP eliminates import taxes as high as 59% on U.S. machinery products exports (the U.S. exported $56 billion worth in 2014) to TPP countries. In the agriculture sector, the TPP will eliminate import taxes as high as 40% on U.S. poultry products, 35% on soybeans and 40% on fruit. In addition, the TPP is expected to help small and medium-size businesses attain greater access to global export markets.

The final agreement now has to be ratified into legislation by each country; however, U.S. presidential elections in 2016 will likely complicate the process. According to the economics team at BofA Merrill Lynch (BofAML) Global Research, the TPP's impact on U.S. GDP growth should be an increase of 1.3% over several years. Gavekal, an independent research firm, argues that the TPP is the most significant trade liberalization deal Japan has ever made. The TPP's biggest beneficiaries will likely be smaller countries, such as Vietnam, that have been subject to higher trade barriers.

Big and bold policy shifts are needed
We believe that developed economies such as the U.S., Europe and Japan will continue to grow this year. However, outside of the stimulative support of monetary policy, these nations will have to implement fiscal policies with the aim of improving long-term growth potential and raising job and income prospects for all their citizens.

There is a growing sense that Congress is moving away from brinkmanship and toward compromise, and that reduces near-term political uncertainty.

In the U.S., we've had more than six years of quantitative easing and zero interest rate policies. At this stage of the recovery Washington needs to embrace a broader agenda to ensure long-term growth by creating incentives for investments and risk taking. In our view, this includes tax reform—especially well-targeted incentives to stimulate private investment and enhance productivity through research and development—and policies to support development of human capital by investing in education, training and improving the effectiveness of this spending. In addition, decades of underinvestment have left America's infrastructure antiquated. The American Society of Civil Engineers gives U.S. infrastructure a grade of D+ and estimates an investment of $3.6 trillion is needed by 2020. We believe that efficient public investment, such as investment in infrastructure, could raise the economy's productive capacity.


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