As economies globally continue the battle against COVID-19, major governments are again gearing up to deploy huge fiscal support measures.
Earlier this week the Morrison government announced a six-month extension to the JobKeeper program holding the economy together, while US lawmakers are ironing out the details on an additional $US1 trillion (~$1.4 trillion) stimulus package.
After flagging a $5bn government surplus this year, Australia’s government now expects to post a deficit of $184bn next June.
And the unprecedented support measures raise the question about what role government spending will play in the global economy, not just to combat the pandemic but over the medium term as well.
Earlier this year, analysts from Macquarie Bank’s private wealth arm said the historic surge in government support was serving to break the “irrational taboo against borrowing and preoccupation with debt sustainability”.
The Macquarie team added that response mechanisms by policy makers would create the necessity for governments and central banks to work more closely together, in a more similar way to how China runs its economy.
An example of that was seen domestically earlier this year when the Reserve Bank purchased $50bn worth of government bonds to support the market functioning mechanism.
However, RBA governor Phil Lowe noted earlier this week that “since late April we have scaled back purchases significantly and have not needed to purchase any bonds for some time”.
For stock investors, it’s become clear that unprecedented government support measures have had a material effect on the outlook for share valuations.
Even after the US Federal Reserve announced a “whatever it takes” approach to the pandemic in mid-March, markets continued to sell off sharply until the US government approved a record $2 trillion stimulus package.
Since then, stocks in the US and Australia posted their biggest monthly gain in April for 32 years, and that rally continued throughout the June quarter even as COVID-19 cases increased.
In the current environment, the principles of Modern Monetary Theory – where governments with sovereign currencies can adopt open-ended spending policies to drive growth and productivity – are now a core subject of discussion among policy makers and financial commentators.
For his part, RBA’s Lowe said in his speech that it was “not possible to put aside the government’s budget constraint permanently”.
Governments that tried that in the past, Lowe said, had typically ended up with higher inflation.
The inflation question
In terms of macroeconomic indicators, inflation is one of the most important indicators for stock investors because it has the most direct relationship with interest rates.
A key feature of global markets in recent years is that historic CPI indicators such as low unemployment have failed to move the needle on inflation.
But if governments have to continue spending their way out of this crisis, could that change?
Macroeconomics commentator Russell Napier is one analyst who thinks it will, predicting in a recent interview that inflation in major developed economies will rise to 4 per cent in 2021 – its highest level in decades.
And in an opinion piece for Bloomberg this week, University of Oregon economist Tim Duy warned that just as the US Federal Reserve was slow to come around to the idea that inflation was going nowhere over the past decade, it may also too be slow to react to rising inflationary forces.
As Napier highlighted, inflation can be useful at the macroeconomic level as a way to effectively reduce government debt. But if inflation expectations rise faster than anticipated, it may cause some turmoil on markets.
Either way, it’s unlikely to be a near-term problem in Australia. In his forecast of domestic inflation levels in the June quarter, Westpac economist Justin Smirk expects to see outright deflation in the local market, with CPI falling by 2.4 per cent.
The post Think Big: Has COVID-19 shifted the narrative around government spending? appeared first on Stockhead.
Barry Stroman was a reporter for Zerg Watch, before becoming the lead editor. Barry has previously worked for Wired, MacWorld, PCWorld, and VentureBeat covering countless stories concerning all things related to tech and science. Barry studied at NYU.