Index > Briefing
Tuesday, September 28, 2021
New Adjustments Necessary in Global Macro Policies

The unprecedented fiscal and monetary stimulus policies of major economies since the COVID-19 outbreak have enabled the global economy to cope with the impact of the pandemic and contributed to the post-pandemic recovery. From a short-term perspective, the prevailing policy of both fiscal and monetary easing once again saved the world from the brink of disaster after the 2008 financial crisis. However, the basis of conventional monetary and fiscal policies has changed greatly in the context of increasingly uneven economic recovery and increasingly pronounced geopolitical conflicts. Establishing effective medium- and long-term policies and defining new boundaries between fiscal policy and monetary policy will be issues that need to be addressed in future macro policy frameworks in response to the increasingly prominent medium- and long-term global economic development needs. In particular, the coordination and linkage of monetary and fiscal policies are facing new challenges in the process of normalizing macro policies in the post-pandemic era.

According to the conventional economic theory and practice, monetary policy has the basic objective of maintaining monetary stability and thus economic stability, while the main task of fiscal policy is to prevent shocks from short-term crises, in addition to adjusting the economic structure in the medium- and long-term by combining with industrial policy. After the 2008 financial crisis, global macro policy practice shows that monetary and fiscal policies are becoming more closely integrated. While addressing the short-term shocks of the crisis, it is eroding the independence of central banks to conduct monetary policy. On the one hand, central banks need to "pay" for the increasingly huge fiscal expenditures; on the other hand, the highly developed international capital market makes the government's financial department has had more and more influence on financial institutions and markets, as well as on the monetary stability. While the combination of monetary and fiscal policy has worked well in dealing with short-term crises, it has also led to a long-term trend of low interest rates, low inflation, rising asset prices, and sovereign debt. Such trend is not conducive to medium- and long-term economic growth. It will erode the vitality of the market and the driving force of enterprise development, and lead to long-term economic and social distortions.

This situation, which has become increasingly evident in the post-pandemic era, has led both policy authorities and market institutions to feel that a new framework needs to be sought so as to enable economic policies based on monetary and fiscal policies to meet the needs of long-term sustainable economic development. The latest annual economic report by the Bank for International Settlements (BIS) also notes the "crossover" between fiscal policy and monetary policies. According to the report, monetary and fiscal policy will face severe challenges in the medium- to long-term, given the fact that there are historically low interest rates and the highest debt-to-GDP ratio. Monetary and fiscal policy must therefore normalize, as conditions permit, re-establish a margin of safety, and operate within a "stability zone" in the medium-term.

The contradiction between monetary policy and fiscal policy has always existed. On the one hand, in the context of the global "massive easing", the space for monetary policy is becoming smaller and smaller, and the impact of monetary policy on long-term economic growth is becoming weaker and weaker. This is increasingly evident in Europe, Japan, and even China. In the United States, which has the advantage of a global currency, the low inflation trend has likewise persisted in the aftermath of the 2008 financial crisis. Central banks are looking for more fiscal stimulus to support macroeconomic stability. In the wake of COVID-19, monetary and fiscal policies have become more closely linked to maintaining the stability of the financial system and the economy. The BIS report notes that the two policies often contradict and exert pressure on each other, a long-standing problem that calls for a clear boundary between the two policies and the establishment of a normalized macro policy framework.

The BIS report also mentions the new normal of "low interest rates and high debt-to-GDP ratio". But it warns that this "abnormal" state is unsustainable in the medium- to long-term. The BIS notes that monetary and fiscal easing has persisted for a long time, and policy space has been substantially reduced. In terms of monetary policy, policy interest rates in major developed economies are around zero and the size of balance sheets has risen further. Even after the recent rise in inflation, interest rates remain extremely low. Moreover, markets believe that such low interest rates should normally be accompanied by higher debt during this stage. Central banks in the four major economic regions (U.S., Europe, China, and Japan) now hold between a quarter and almost half of the total outstanding government debt. In terms of fiscal policy, the global government debt-to-GDP ratio has soared, rising by about 10 percentage points so far. While emerging market economies have lower debt ratios than advanced economies, they generally have less room for policy adjustment. In this case, the policy authorities may find it difficult to cope with possible future economic fluctuations. At the same time, when real interest rates are below zero, a well-functioning economy cannot last very long and allocate capital efficiently. This means, in effect, that monetary and fiscal policies need to be coordinated for a proper exit and normalization following the crisis response.

Recently, we have noticed that the Federal Reserve has actually begun to shift its stance as well, pushing for a tapering of accommodative policy. Fed Chairman Jerome Powell, who has repeatedly insisted on the view of temporary inflation, said the Fed would begin normalizing policy to restore the Fed's effective monetary policy space regardless of whether inflation slows down in the future. But the dilemma for central banks, including the Fed, is that after economies have become accustomed to long periods of low interest rates, it becomes increasingly difficult to restore and raise real interest rates as macro leverage increases. High government debt (and high private debt) makes it harder to raise interest rates as the economy becomes less affordable. The overall economy, which has adapted to low interest rates for so long, has instead become more vulnerable, and fiscal policies are increasingly sensitive to higher interest rates. As borrowing costs are at structurally low levels, governments have an incentive to take advantage of low interest rates to raise debt. Therefore, the adjustment of the monetary policy cycle in the conventional sense faces significant obstacles. Over time, there will be less room for fiscal and monetary policy and the economy will be more vulnerable to future recessions.

Chan Kung, founder of ANBOUND, said recently that the world is experiencing its "darkest hour" in which conventional rule systems were disintegrating and new ones were being tried out from all sides. The same is true in the economic sphere. At present, the continued monetary and fiscal easing after 2008 also needs to be re-examined as a whole. At the same time, in terms of new changes, there is a growing need for structural economic reforms to boost long-term growth.

On the whole, the new policy framework is different from the previous ones, and the degree of integration and coordination between fiscal and monetary policies will be further deepened. However, the current "unlimited" easing may not be sustainable. As the BIS points out, the "new normal" of this policy needs to be changed, in particular the boundary between monetary and fiscal policies needs to be established to improve policy stability and transparency. At the same time, it should be pointed out that although the economic and financial environment has changed greatly, the basic economic logic and theoretical analysis methods have not yet changed. Whether it is the practice of Neo-Keynesian theory or the debate of modern monetary theory (MMT), the more critical issue is how to re-establish the healthy relationship between monetary policy and fiscal policy, so as to avoid unpredictable consequences to the macro economy in policy practice.

Final analysis conclusion:

Driven by global monetary and fiscal easing, economies are recovering from the impact of the pandemic. Having achieved results in the short term, macro policies need to be adjusted to promote medium- and long-term economic growth. This requires not only establishing the boundary between fiscal and monetary policy, but also reconsidering the relationship between the two.