Fiscal Focus
Episode publishedPodcast: Goldman Sachs ExchangesGoldman Sachs Exchanges
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From Goldman Sachs Research, this is Alison Nathan. Welcome to Top of Mind, a podcast that explores macroeconomic issues on the minds of our clients. In this episode, we explore whether governments should be doing more to boost the economy by either directly spending more money in the economy, for example, by funding public infrastructure or by cutting taxes so that people or companies have more money to spend themselves. The counterpart to these types of fiscal policies conducted by governments is monetary policy conducted by central banks. This is typically the first line of defense when eco
Today, we are in a situation where low interest rates are not delivering the same degree of stimulus as in the past. Because the rate of return on investment in the economy has fallen. Monetary policy can still achieve its objective, but it can do so faster and with fewer side effects if fiscal policies are aligned with it.
This call for fiscal expansion might seem like a no brainer. But the downside is that if governments spend more money or take in less revenue by cutting taxes, they're likely going to end up running a budget deficit, and especially if the deficit is large, could end up with high debt levels. Historically, high debt levels have been associated with lower growth over the longer term and increased risk of a crisis. So whether the benefits of running larger fiscal deficits today outweigh the costs is top of mind. To get some perspective on this debate, I first sat down with Olivier Blanchard, who
Nearly by definition, the arithmetic of that dynamic says, TV interest rate is lower and especially if it's slower than the growth rate for some time, then the debt dynamics are much less unattractive. You basically get more fiscal room, you can have larger deficits and pay a smaller price in the future. The risk that you run debt to levels which would require very large primary surplus is much lower. So it's clear that it increases the room to use fiscal policy. Is
it right to believe, though, that rates will stay low for the foreseeable future? Shouldn't we be somewhat worried that markets are just wrong here?
Yeah. Nothing is up for sure. So one should always be careful. But I think there are many reasons to think that markets have it right. First, I mean, it is not a fluke. It's an evolution which started at the mid-80s and has been going on more or less steadily since then. But the decrease in real interest rate is really a long trend. If you look at the yield curve, markets are fairly convinced that rates will remain low. If you look at option prices, markets put a very low probability on rates increasing. They could be wrong. But also when you look at the factors which are behind the real rates
How much do you think fiscal stimulus makes sense today purely because interest rates are so low? Or is there a case for fiscal stimulus even beyond this fact?
Even if fiscal policy had no effect in the short run on demand, the fact that the interest rate is lower implies that there are aspects of fiscal policy that you may want to reconsider. For example, the case for public investment is clearly stronger than lower than cost of borrowing. But the overwhelming case is really the fact that because my true policy cannot help, fiscal policy really has to be used to maintain output more or less potential. That's the main case. And I would say that short of very exotic, much more
unconventional
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