Don't Count on More 'Trumponomics' Fiscal Easing Rallies

 | Feb 14, 2017 | 8:00 AM EST
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As the "Trump rally" continues, investors may be tempted to believe that if populists come to power in other countries, especially in Europe, they will relax fiscal rules, too. But investors may be wrong.

The main reason for the Trump rally has been his promise to loosen fiscal policy. The "phenomenal" tax reform that he pledged eagerly is awaited by investors, who are ready to overlook other shortcomings of his fresh presidency for its sake.

With monetary policy almost exhausted by incessant asset purchases and record low interest rates, it is understandable that investors have begun to look toward fiscal policy as the next tool to be employed by policymakers.

However, it may not be that easy. Analysts at economic research house Oxford Economics surveyed their economists in 20 big countries and built a "fiscal populism indicator" to try to gauge the extent to which Trump's victory may herald populist-driven fiscal expansion elsewhere.

The result, in a nutshell: not much. "The 'Trump rally' was most likely as good as it gets," Melanie Rama, global macro economist, and Gabriel Sterne, head of global macro research, wrote in a note about "global fiscal populism."

"Populists have traditionally been more inclined to spend money and a surge in global populism is likely to -- at least to some extent -- challenge more conservative fiscal policies and institutions," they said.

But the two analysts' baseline scenario expects fiscal expansion to amount to less than 0.1% of world gross domestic product, or around $50 billion, per year in the next three years. Most of it will come from the U.S. and China, with Trump's fiscal impetus boosting appetite for fiscal easing elsewhere and China perhaps pursuing more expansionary fiscal policy to meet its growth targets.

Although it can be argued that it is the countries in the eurozone that need fiscal relaxation more than the U.S., they are the least likely to see it. Perhaps with the exception of France, the other major eurozone members probably will stick to the European Union's Stability and Growth Pact rules of fiscal prudence.

On the scale of probabilities for populist-fueled fiscal expansions, the Oxford Analysts have France at 20% compared with 66% in the U.S. Marine Le Pen, the anti-immigration leader of the extremist Front National party, has said a government run by her party would allow the central bank to buy government debt outright, thus financing social spending such as welfare and infrastructure investment. At the same time, corporation taxes will be reduced.

This scenario will sound tempting to some voters, who are likely to confuse it with a pro-business stance. But that type of spending elsewhere in the world -- Venezuela and Zimbabwe come to mind amid more recent examples -- has caused hyperinflation and the collapse of living standards.

Elsewhere in Europe, Geert Wilders, the anti-European Union, anti-immigration leader of the Dutch Party for Freedom, is a proponent of income tax cuts and tax relief for households. The Oxford Economics analysts put the probability of fiscal easing in the Netherlands at 20%, the same as in France.

In Italy, the probability is lower, at about 15%; it is possible that Beppe Grillo's anti-EU Five Star movement will seek to increase fiscal spending, but his focus is more on politics than the economy.

While fiscal stimulus may indeed work over the short term to boost economies, just like monetary stimulus it will not address the fundamental reasons for the economic slowdown. Reducing corruption and bureaucracy, rethinking sclerotic labor laws and improving the business environment by encouraging start-ups are crucial for economic progress in the eurozone.

In the years ahead, the countries that will be doing those kinds of reforms will be the most likely to prosper. These are the types of stimulus that investors really should hope to see.

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