Does the Global Economy Need a Shot in the Arm?

To stimulate growth or not? That was the question occupying politicians on both sides of the Atlantic last week. On our shores, with recession fears swirling, President Trump said he was mulling a payroll tax cut and other forms of fiscal stimulus. Meanwhile, on the heels of Q2’s small GDP contraction, German Finance Minister Olaf Scholz jawboned about a potential €50 billion package aimed at jolting the economy. But investors’ hopes soon fizzled. First Trump U-turned, saying cuts were off the table. Then Germany’s central bank threw cold water on the idea that stimulus was necessary, making any potential stimulus package unlikely to clear the necessary bureaucratic hurdles. While many decry this reversal, we think this outcome is probably just fine for stocks. Fiscal stimulus can help in a pinch, but we don’t see much evidence the conditions are right today.

Fiscal stimulus refers to the government giving demand a jump-start, usually through some combination of tax holidays, tax rebates and spending on infrastructure and construction projects. Past stimulus efforts have taken various forms. In 2001’s recession, stimulus accompanied the Bush tax cuts in the form of one-time tax rebates sent to most taxpayers. In the 2008 – 2009 recession, Congress again passed out stimulus rebate checks for most workers and Social Security recipients. President Obama shepherded further rounds of stimulus, including a temporary two percentage point payroll tax cut and hundreds of billions of dollars in public works projects.    

In our view, fiscal stimulus is most useful in a recession, when consumers and businesses are most risk-averse. We don’t think stimulus is necessary to end a recession, but it does inject the economy with quick money, which can get things moving faster than they otherwise would have. Governments may not spend in the ideal form, although “ideal” is always a matter of opinion. However, the initial spend doesn’t really matter—what matters is money changing hands, getting spent and re-spent. That lifts the velocity of money, which can spark economic activity and help growth resume.

But during expansionary times, fiscal stimulus isn’t necessarily the most useful even if growth starts to slow. When construction projects are already happening on their own, governments getting into the mix usually just ends up redirecting rather than creating investment. Often it runs the risk of crowding out private activity that might have had more of a positive effect on overall growth. In our view, stimulus-oriented spending under these circumstances at best amounts to government picking winners and losers. As for temporary tax cuts, they are nice, but unnecessary when the economy is chugging along. Moreover, they don’t have a preset economic impact. Consumers could spend their windfall, or they could save it. The economy is a complicated beast and impossible to manipulate by pulling levers.

On paper, Germany is a better candidate for stimulus than the US, but even there it probably isn’t necessary or likely to help much. GDP wiggles regularly happen during a broader expansion. You only have to look back a few quarters to see this. German GDP contracted in Q3 2018 and then expanded in Q4 2018 and Q1 2019. Exports’ -1.3% q/q decline bear most of the blame for Q2’s contraction.^[i] Stimulus aimed at domestic demand—like the mooted €50 billion spending plan or a newer plan to incrementally cut corporate taxes—wouldn’t really address this. At best it might help address the tiny pullback in business investment, but that stemmed mostly from construction, a sliver of Germany’s economy.

Meanwhile, US GDP hasn’t even contracted. Nor is there much evidence domestic demand is flagging.  The latest snapshot from the Atlanta Fed’s GDP Now—which aims to give a real-time assessment of quarterly growth based on incoming monthly data—estimates 2.3% annualized growth in Q3, a slight acceleration from Q2’s 2.0%. Tax cuts would target consumers, who aren’t holding back. Consumer spending grew 4.7% annualized in Q2—and jumped again in July.^[ii] A slight bump from a payroll tax cut might be nice, but taxes don’t seem to be holding back spending. Indexing capital gains for inflation, another mooted measure, could ease the tax burden for those needing to sell appreciated assets. But it isn’t likely to produce massive windfalls. The Tax Foundation estimates it would boost US GDP by all of 0.11percentage point cumulatively over 10 years, assuming models hold—a tall order. Granted, consumer spending isn’t the economic swing factor—that honor goes to business investment. That did fall a bit in Q2. But looking under the hood should ease some concerns. Investments in structures, which fell at a -9.4% annualized rate, drove the decline.^[iii] This category, which includes oil wells, has gyrated throughout this expansion, occasionally plunging as oil prices fell. Other categories of business investment—namely equipment and intellectual property products (which includes research & development), remained positive.