The conversation regarding whether there is room for more aggressive fiscal policy is a hot political topic today. In the US, the debate is likely to become even more inflamed as we approach the midterm elections. In fact, these are at risk of becoming an evaluation of President Biden’s policies in light of the excessive fiscal spending carried out in response to the Covid pandemic (and its subsequent impact on the economy). On the one hand, fiscal expenditure has been identified as a leading cause of higher inflation. On the other, greater spending may be required should the US economy decelerate more than expected, particularly as voting day is rapidly approaching. Likewise in Europe, greater fiscal action is required to subsidise skyrocketing energy costs and to limit the economic impact of the Ukrainian conflict. At the same time, concerned voices are being raised as to whether harmonised Stability and Growth pact rules are still appropriate for the Union.
Additionally, gauging the scale and scope of the fiscal impetus implies revisiting the role of monetary policy as well. For several years, monetary policy has assumed a dominant role in the policy mix. It was widely regarded as a panacea to heal the wounds of the great financial crisis in a low growth, low inflation world. Little by little, the limitations of non-conventional policies are becoming apparent. Although low (and sometimes negative) interest rates have been a weak incentive for investments, the resources dispensed by policymakers have mainly been funnelled into financial markets rather than the real economy, generating a discrepancy between market prices and fundamental values. Consequently, the social inequality gap has also widened, albeit indirectly.
Nonetheless, starting with the Covid pandemic, and later accentuated by the conflict in Ukraine, fiscal policy has made a strong comeback on the policy mix stage. It has been called upon to support growth in a context framed by the energy crisis, through structural investments and reshoring in certain strategic sectors (such as healthcare and defence), where vulnerabilities (due to underinvestment) have been exposed by recent international developments. Over the long term, fiscal policy will also need to face the structural challenges that lay ahead, such as the green transition, which will require massive amounts of funding.
The entire debate surrounding fiscal policy is taking place at a time when debt accumulation is at historical highs (in absolute terms and also relative to GDP), with wide divergences across countries and regions.