LGIM: It may be time to loosen the fiscal purse strings

Legal & General Investment Management (LGIM) predicts coordinated monetary-fiscal policy could revive growth and stoke inflation.

Despite exceptional and prolonged easing by central banks in the years since the financial crisis, global growth remains sub-par and inflation hovers near historical lows.

There are a number of reasons why monetary policy has not been more successful post-crisis. LGIM Senior Economist Magdalena Polan suggests a significant contributor has been tight fiscal policy, due to its negative impact on growth and expectations.

“Fiscal austerity has a more negative impact on the economy when growth is already weak. Tightening fiscal policy soon after the recession, especially in the euro area, therefore likely prolonged the slowdown,” Polan said.

This has led to calls for relaxing fiscal policy to support growth directly and to increase the effectiveness of monetary policy. And indeed, both economic theory and empirical evidence suggest a fiscal boost and closer policy coordination would be more effective together.

In contrast to monetary policy, whose effects are inherently uncertain and indirect, fiscal easing would support economic output directly in the short term by increasing demand.

“But not all countries would benefit from fiscal expansion. Those with weaker institutions may not see an impact on growth. Still more lack the necessary ‘fiscal space’ to accommodate government easing,” Polan said.

Countries that suffered from the financial crisis, as well as a range of emerging market economies that are still adjusting to lower commodity prices or weaker global trade, have seen a relatively fast increase of debt in recent years and have less space to increase debt without triggering sustainability concerns.

“However, these countries may still benefit from the spill-overs of increased investment demand elsewhere,” she said.

Alicia Villegas
Alicia Villegas speaks Spanish and Italian and is Iberia Correspondent for InvestmentEurope. She was shortlisted for the Rising Star Award at the British Media Awards 2017 and Writer of the Year at the PPA Independent Publisher Awards 2016. Previously, she worked for almost three years at the seafood business website Undercurrent News as a market reporter. In Spain, she also worked for more than five years for several media outlets.

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