March 11, 2009
“In the long run we are all dead”. In that short quip, John Maynard Keynes famously criticised the hands-off attitude of policy-makers in the 1930s, when short-term economic stimulus was badly needed. Keynes might be proud of today’s policy-makers. But can we afford all of the stimulus?
Without question, today’s announced fiscal measures are massive. In its latest forecast, the IMF calculated that total stimulus in the G-20 nations amounted to 1.5% of GDP. That number is likely to rise. The US government has announced a projected deficit this year of $1.7 trillion, or 12.3% of GDP, and as economic weakness deepens, other countries are likely to sweeten their outlays. Emerging markets are also in the game. Many have announced stimulus measures, led by China, where the $586 billion plan amounts to a whopping 13.7% of 2008 GDP.
The first hurdle to the spending was cleared with remarkable ease. Prudence was the hallmark of fiscal policy over the past 20 years, and as little as a year ago, most voters required tight money management by their governments, or else. Overnight, the gravity of the economic situation has led voters to accept short-term deficits as absolutely necessary, in stark contrast to the 1930s.
That very prudence, together with fiscal windfalls in the good times, has created a lot of fiscal capacity. Primary fiscal finances of G-7 countries have for the most part moved toward balanced or surplus positions in recent years, with the overall trend in the right direction. The EU Stability and Growth Pact has ensured fiscal discipline on the continent, and among hopeful members. Other OECD nations have likewise implemented prudent policy. At the same time, those emerging markets – and there is no small number – that elected to generate surplus funds during the boom years have a cash stash that is now being used to stabilize economic performance.
What did all that prudence achieve? Most governments stabilized net public debt as a share of GDP in the past decade, and at levels that allow for temporary deficit spending. Average net debt-to-GDP in the US, UK, France, Germany and Canada is 36%, down from 40% just five years ago. Italy’s rate is high at 87%, constraining its current fiscal room, but is down substantially from a peak of 107% in 1998. Among major nations, Japan’s current position is least favourable. Well over a decade of significant fiscal pump-priming has increased Japan’s rate from under 20% - a model of fiscal management – to just under 90% of GDP, a stunning reversal, and placing Japan in a league with Italy, Greece and Belgium, except in their cases, the fiscal record is improving. Among large nations, Canada stands alone in recent fiscal management. Years of successive surpluses have reduced Canada’s debt-to-GDP ratio steadily, to a relatively scanty 22% in 2008.
Clearly, most large nations, along with a bevy of emerging markets, have the means to finance their hefty short-run stimulus plans. And as long as fiscal deterioration is similar across countries, financial markets should not weigh too heavily on individual nations over the next two years.
The bottom line? The fiscal tap is wide open, and for now, many can afford it. Keynes will truly be proud of policy makers if this time, unlike previous episodes, they manage to close the spigot in time. If not, as Japan has shown, fiscal finances will rapidly deteriorate into the danger zone.
The views expressed here are those of the author, and not necessarily of Export Development Canada.