'Growth-friendly' fiscal adjustments required to combat high-budget deficits
The Canadian and U.S. governments have been urged to start thinking about “growth-friendly” fiscal adjustments after the pandemic to help reduce high-budget deficits.
Todd Mattina, chief economist, portfolio manager, Mackenzie Multi-Asset Strategies team, believes these deficits remain essential to underpin the fragile economic recovery and back up analysts’ forecasts of a rebound to pre-pandemic levels of GDP and corporate earnings by the end of 2021. Now is the time, he stressed, to formulate these plans while conditions are favourable.
He added that while fiscal policy has played a key role in supporting household consumption and preventing even greater joblessness and business bankruptcies, the surge in deficit-financed spending has raised investor concerns about both long-term fiscal solvency and short-term macro-economic stability.
“Despite these concerns, we believe that high-budget deficits will be needed for several years to support a recovery to the pre-pandemic trend. In addition to stabilizing economic activity in the current recession, active government spending supports long-term debt sustainability by contributing to the economic recovery.”
In short, fight debt with more debt. There has been huge fiscal support deployed in 2020 to keep the economy afloat, of course. However, headwinds persist – the second wave, a fractious U.S. election – that could well delay business investment and slow the recovery. Mattina said the stimulus seems unlikely to cause inflationary pressures, with investors expecting inflation over the next decade to average about 2%. It means now is the time to reduce these risks, he added, and formulate a post-pandemic growth plan.
“We believe the ideal fiscal adjustment should be growth friendly by protecting productive infrastructure investments, avoiding poorly targeted across-the-board expenditure cuts to focus on the least productive areas of spending, such as subsidies, and closing tax loopholes.
“Fiscal adjustment should also be implemented in tandem with deregulation to boost private investment. The composition of fiscal adjustment after the pandemic should also differ in each country. In the US, entitlement reforms are important to control long-term spending growth. In Canada, controlling growth in healthcare spending will be important. Avoiding the temptation to cut public investment will also be important to engineer a growth-friendly fiscal adjustment.”
For the financial markets, a failure to maintain aggressive fiscal support to avoid a “low-growth loop” would be bearish for stock markets, corporate credit and the Canadian dollar. Mattina believes that when COVID-19 is in the rear-view mirror, governments must reassure investors of their long-term solvency.
He explained: “The key question is whether governments will wait for market pressure on currencies and sovereign rates before acting, as Canada experienced in 1995, or if they will develop credible long-term fiscal anchors while financial conditions remain highly favourable today.”