In Metallica’s self-titled album from 1991, which some call the “Black Album,” the theme of the album seems to be about entering a new and uncertain future. This could be because it was released just as the Cold War was ending.
The literal interpretation of “Enter Sandman” is about being taken to “never-neverland,” which is an unknown place. “Wherever I May Roam” has multiple presumed meanings, one of which is about being a nomad, out in the world and the chaos that comes with the freedom. “Sad But True” is about how future outcomes are based on past decisions and how we can’t escape our past.
It’s a thought that highlights why governments in the world reacted the way they did during the COVID-19 pandemic and why certain fiscal policies were enacted.
But are there any long-term implications of policies implemented during the past two years?
Many of these policies were necessary to mitigate a deep and protracted economic crisis. But perhaps it’s time to analyze the economic benefits of these policies, and how these past decisions could affect future outcomes.
In this current piece, we’ll look at:
- Fiscal policy itself (as a concept)
- Why it’s the go-to policy choice for governments
- How countries responded to the 2008 and 2020 challenges
- The impact of this spending on the overall global government debt stock
Fiscal Policy Is Basis of All Human Activity
Fiscal policy sounds like two already boring words conjoined to making an even more drab phrase. But it’s a very basic concept, as old as human civilization itself. It’s simply where and how a person or government collects money, versus where and how they spend the money.
The difference between the two is either a surplus or deficit. And a deficit is often funded by issuing debt, also known as government bonds. Increase spending or collect less revenue (tax) and a country has a fiscal deficit. If those deficits persist, then it starts to accumulate debt.
I’ve always said that socialism, communism, capitalism or any other economic theory is largely a difference in fiscal policy. The common denominator differentiating them is where, when and how the different models of economics choose to raise revenue (tax) versus where, when and how they chose to spend the money.
We engage in a version of fiscal policy in our day-to-day lives when we determine which shirt to buy or where to eat. For example, a person may buy something cheap to save money, or purchase something expensive and save less. The difference though in a person’s choice of what shirt to wear doesn’t really move the overall economic growth needle, or the potential for political violence for that matter, as we’ll see shortly.
However, when a government makes the decisions, it can have significant macro consequences. And this is precisely what we wanted to explore.
An Uptick in Fiscal Stimulus in 2020
The global response to the pandemic was very similar to the 2008 Global Financial Crisis (GFC), even though the culprit was very different. The response to both was an easing of monetary policy, like cutting interest rates, to spur borrowing demand and make credit and liquidity cheap and readily available, coupled with heightened government spending, like a fiscal stimulus. The one difference though is that while in 2008 almost all countries cut interest rates and engaged in monetary easing, it was mainly the U.S., Western Europe, Japan and China that engaged in fiscal stimulus. However, in 2020 nearly every country ramped up fiscal spending.
This raises two questions:
- Why did more countries engage in fiscal response in 2020 relative to 2008?
- Why engage in fiscal stimulus at all?
First, 2008 was largely a U.S. economic crisis that then became a global challenge. The U.S. faced a housing crisis, which led to overall economic weakness, including:
- Falling employment
But most of the rest of world was facing economic weakness due to weak U.S. demand and volatility in capital markets. So, countries faced some sort of economic headwind. However, the fundamentals of their economies – particularly the more insulated ones – were generally sound. COVID-19, on the other hand, affected all countries in the same way. Even insulated economies faced internal economic weakness as demand and economic activity declined. Accordingly, we saw a more uniform response on the fiscal front.
Why Countries Engage in Fiscal Response
Second, countries engage in a fiscal response because it’s often the fastest and most impactful method of putting a floor on economic activity, while simultaneously trying to boost it. Gross Domestic Product (GDP) is the collective output of a country and can be calculated by adding up:
- Private Consumption: Where we as individuals spend our money
- Private Investment: Where we and corporations invest our money
- Net Exports: The net value of goods we ship abroad, since that brings in money
- Government Investment: Where the government spends money
Pulling on any and all of those levers can make an economy grow or shrink. The first three levers are very hard to pull on and solicit an immediate reaction. However, governments can easily pull on the fourth – government investment and spending.
This can come in the form of infrastructure spending, which is currently being debated in the U.S. In general, expanded government budgets and spending can be a growth additive. But not all spending is the same. Thus, targeting spending on economic growth inducing areas like infrastructure, construction or procurement of supplies can be the most impactful. Plus, let’s not forget that this form of spending can also create jobs, and the holders of those jobs may increase their consumption (the first part of the equation).
Governments can indirectly control the other three levers, too. Often, tax incentives, abatements, deferments and reductions can incentivize individuals to consume more, invest or manufacture goods to export. While this is not spending, it does often result in less revenue collected by the government and thus is considered fiscal stimulus.
Essentially, any action by the government that injects money into the economy, either through a direct increase in spending or through policies that reduce government revenue and thereby increasing the fiscal deficit or lowering the fiscal surplus in surplus nations, can be referred to as fiscal stimulus. And the object is to grow the economy.
Stimulus and Debt
As I mentioned earlier, when the fiscal deficit is widened on account of stimulus, it’s funded by the issuance of debt (government bonds). Following the ramp up in U.S. deficits in 2008, and again in 2020, we saw an increase in the supply of U.S. Treasury securities. Traditionally, the accumulation of debt is seen as a negative and too much of it is in fact not good. However, we would argue that some levels of debt are actually quite important, if not imperative, for a properly functioning financial market.
Case in point are the U.S. and Australia. In late 2001, U.S. fiscal deficits had fallen to the point that the U.S. Treasury stopped issuing the 30-year bond. But as spending ramped up due to the Iraq War, and deficits widened, the instrument was brought back by 2005. However, the four-year halt created a gap in the U.S. yield curve, which some could argue affected price discovery in the long end of the yield curve.
But what if the U.S. never brought back the 30-year? Over time the U.S. yield curve would have topped out at 10-years. This in turn would have caused challenges for corporations issuing debt as they (and other countries) often price their debt in instruments as a spread to the U.S. yield curve. And corporate bond traders would have hedged their investments by shorting U.S. Treasuries. Without a 30-year Treasury bond, it would have been difficult for corporations to issue, and for traders to hedge, a 30-year corporate bond.
Similarly, in the 1990s and early 2000s, Australia mostly ran surpluses and had a very limited supply of government bonds because they did not need to borrow much. As a result, the Australian government bond market lacked liquidity and a few investors could easily buy up all the government debt. This limited transparency and liquidity in the government bond market. Of course, it’s great to run surpluses, but there can be some adverse effects to not having deficits and debt. Just like our personal finances, some level of debt can be beneficial if calibrated properly.
Thus, some debt is good, and helps maintain a liquid government bond market, which is the bedrock of all financial markets. But too much debt is naturally problematic, as we’ve seen recently in Greece, Italy and Argentina. What happens if private investors no longer want to buy a government’s debt? Not only would yields spike raising the cost of borrowing down the road, but the country could go into default as it may not be able to refinance its debt. And that’s precisely what we are focusing on with this publication.
The Increase in Fiscal Stimulus in 2020 Will Lead to a Surge in Global Government Debt
We now know that 2020 was a historic moment for global debt. As we noted above, more countries engaged in fiscal stimulus relative to 2008 causing a significant spike in global government debt, which is now close to 100% of global GDP.
COVID-19 hit in 2020, and if we compared 2019 (before COVID-19) to 2021 (since most of the debt was added in 2020), we can see that debt-to-GDP spiked from 83% to just below 98% – a near 15-percentage point increase. Post GFC, debt-to-GDP increased from 64% to 77% in 2010 – a 13-percentage point increase. Globally, the percentage increase is similar, but in nominal terms it’s much more since we are talking about global GDP being much higher. Plus, reaching 75% debt to GDP globally is much different than 100% as funding the debt becomes a question of the availability of global savings and liquidity. If global savings is a function of GDP, which is directed towards investment activity like buying government bonds, then the availability of savings declines as debt rises. Hence why debt-to-GDP in excess of (let’s say) 75% or so is viewed as unfavorable, especially for many developing countries. And the same argument could be applied on a collective global basis.
In nominal terms, the largest increases in debt between 2019 and 2021 came from the U.S., China, Japan, Germany, UK, India, France, Italy, Canada and Australia – the largest economies. And again, we are opting to look at a two-year window since the growth was clustered between 2020 and part of 2021.
But when observing a two-year window around GFC to the two-year window around COVID-19, we start to see the magnitude of just how much nominal debt was added during the pandemic relative to 2008. For example, U.S. debt increased by $6.9 trillion during COVID-19 compared with $3.5 trillion during GFC. For China, it was $3.4 trillion versus $800 billion, and in India it was $520 million versus $240 million.
At this juncture, we can conclude that fiscal stimulus was/is the desired policy prescription during an economic crisis because governments can easily pull this lever to support GDP. And given the dynamics during COVID-19, which stemmed from shutdowns and a loss of economic activity, fiscal policy was arguably more impactful than monetary policy with respect to the real economy (particularly in the short-run). Thus, fiscal stimulus was the go-to tool, and arguably more widely used during COVID-19 relative to GFC in 2008.
We can substantiate this statement by looking at the increase in global debt-to-GDP, as well as by scanning the breadth of countries that increased spending, and the nominal levels of debt increases, too.
In Part II, I’ll look at the economic effects of the policy decisions and how it could affect our thinking about the likelihood of political violence in various markets.
Read Deficits, Debt and Violence: The Economic and Political Implications of Pandemic Stimulus Part 2
La información proporcionada en estos materiales brinda información general y de asesoría. It shall not be considered legal or medical advice. The Hartford does not warrant that the implementation of any view or recommendation contained herein will: (i) result in the elimination of any unsafe conditions at your business locations or with respect to your business operations; or (ii) be an appropriate legal or business practice. The Hartford assumes no responsibility for the control or correction of hazards or legal compliance with respect to your business practices, and the views and recommendations contained herein shall not constitute our undertaking, on your behalf or for the benefit of others, to determine or warrant that your business premises, locations or operations are safe or healthful, or are in compliance with any law, rule or regulation. Readers seeking to resolve specific safety, legal or business issues or concerns related to the information provided in these materials should consult their safety consultant, attorney or business advisors. All information and representations contained herein are as of April 2022.