Tax and spend

22 November 2016 | Markets and Economy


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Leo Schulz: Tax and spend; the idea of an active fiscal policy has been out of favour since the 1970s. My name is Leo Schulz and I have with me Peter Westaway, Chief Economist and Head of Investment Strategy at Vanguard Europe. Peter, why are authorities rethinking fiscal policy?

Peter Westaway: I think the main reason why they're rethinking it is simply the main tool of stabilisation, monetary policy is getting to the end of its road; the interest rates are as low as they possibly can be; QE, Quantitative Easing is being used, but there are question marks about how effective it can be over the long term, so people are looking around for other policy instruments that can either replace or augment monetary policy in stimulating demand.

Leo Schulz: So Peter, what kind of form or shape can fiscal policy take?

Peter Westaway: Quite simply there are two different types of fiscal policy in its simplest terms; one is government spending, so the government can spend more money on goods and services or even on long term investment like infrastructure spending for example on roads.

Leo Schulz: So roads, HS2, that kind of thing?

Peter Westaway: All of those sorts of things; on the other hand, the government can put money into the hands of consumers by cutting taxes, which is a way of boosting consumer spending; that's another way of boosting the economy.

Leo Schulz: Peter, I believe this chart relates to the euro area. What is it that we're looking at?

Peter Westaway: This chart shows the contribution that fiscal policy has made to growth in the euro area over the last five or six years. And what it shows really clearly is that while the euro was going through a period of austerity, when governments were trying to bring down their deficits because their debt was too high, then these blue bars pointing downwards are saying that there was a big drag on growth. Growth was really being held back by the effects of fiscal austerity.

Leo Schulz: So we would be looking here, say in 2011, where the overall GDP of the euro area might have been say, 1.5% lower than it would have been due to fiscal austerity?

Peter Westaway: Exactly. And so monetary policy would be working at the same time, which might be trying to offset that, but fiscal policy's typically a pretty powerful instrument.

Leo Schulz: And quite a strong difference, isn't it? Quite a significant difference that we've got there.

Peter Westaway: And then when you look forward to the present and into the future, what we're seeing is that first of all that austerity drag has disappeared, not because the austerity's completely gone away, but just because it's stopped getting tighter. This year, this positive bar is in 2016; what we've seen is in a few countries, fiscal policy has actually been more generous than had really been intended. Some countries ended up missing their fiscal targets; that meant their growth was stronger than it otherwise would have been. So many commentators are saying, 'well how about having a little bit more loose fiscal policy in the years going forward?' But what we can see here, from the forecast – and these are actually the IMF's forecasts – is that there's actually no prospect in the forecast of positive contributions from fiscal policy.

Leo Schulz: But certainly not as negative as they were in the past. An active fiscal policy – not the answer to everything, but clearly some real potential to make a difference toward a more positive overall economic policy. Peter Westaway, thank you very much.

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