E A Pessimist Warns While Stocks Go Up

Russell Jones writes (for Llewellyn Consulting LLP) about his pessimistic outlook for future macroeconomic policy:

"The misuse of fiscal policy over the much of the post-war era is little short of a tragedy. Time and again governments were happy to embrace fiscal expansion in even the mildest downturns, but then found excuses not to unwind stimulus in the subsequent upswing.

"Furthermore, the effects on government deficits and outstanding liabilities of this habitual policy asymmetry were regularly compounded by optimistic forecasts, politically motivated tax cuts, the supply-side effects of which were often overstated, and a failure to make allowances for the temporarily benign influence of demographic factors on public finances or the [need for facing] a major future financial shock.

"The result was historically high public sector debt then further inflated by the fiscal imperatives of the Global Financial Crisis. However, once the worst of the crisis was past, with more malign demographic[s] felt on public sector balance sheets, the overwhelming focus of fiscal policy became debt sustainability, if not a desperate scramble for solvency. The scope to use fiscal policy actively to respond to new demand shocks was widely perceived to have been exhausted.

"Yet the results of 5 years of onerous budgetary adjustment have been disappointing to those who viewed it as unavoidable. Initial hopes of ‘expansionary fiscal contractions’ rapidly evaporated. Instead it became clear that fiscal multipliers are greatly magnified when economies are all following the same consolidative policy prescription. The headwinds to growth proved formidable, jobless rates [failed] to fall, and real incomes suffered a prolonged squeeze. But the real indictment of this strategy is that budget deficits remain large and public sector debt burdens have continued to climb to new heights, while tax burdens have risen to levels that impinge on incentives, infrastructure spending has been neglected, and elements of society least able to fend for themselves [have been] put under extreme duress.

"Austerity fatigue is building. Political landscapes have become more fragmented, mercurial, polarised. Nationalism and populism are on the rise. Fiscal slippage is likely to escalate, deficit and debt targets will be overshot, and governments will increasingly to move the policy goalposts. There is also the strong possibility in Europe that further large sums will need to be spent in fixing a still dysfunctional financial system.

"With fiscal policy severely compromised or widely perceived to be so, monetary policy has had to shoulder the overwhelming burden of macroeconomic stabilisation. With output dropping far below trend and [slow] to recover, financial sectors in trouble, and inflation uncomfortably low, central banks have pushed nominal policy rates down to the zero bound and pursue other unorthodox strategies: asset purchases and variations on forward interest rate guidance. The Fed may have begun to scale back its bond buying, but both the Bank of Japan and the ECB are preparing the way for yet more unconventional initiatives. There is more unorthodoxy to come.

"With animal spirits depressed and banks still in trouble, the effects of unorthodoxy have not matched expectations. There is only so much demand for goods and services that can be brought forward from the future. Recovery has been shallow, patchy, and subject to serious set-backs.

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