Germans and Swiss stick to fiscal rectitude
After many years of extremely accommodative monetary policy, many observers believe the time has come for fiscal policy to take the lead. As the ECB president Mario Draghi at the last press conference said “it’s high time, I think, for fiscal policy to take charge”. Through its newly re-launched asset-purchase programme (‘quantitative easing’), the ECB is creating considerable room for governments to exploit the current low-rate environment. In its latest assessment of the Swiss and German economies, the International Monetary Fund (IMF) also called for looser fiscal policy to relieve pressure on monetary policy.
Switzerland and Germany are good examples of countries that have fiscal room but have been reluctant to use it. Indeed, the European Central Bank (ECB) and the Swiss National Bank (SNB) have conducted extremely accommodative monetary policies for many years. This is because, despite a notable drop in economic momentum, the pain threshold has not been breached. In addition, strong support for fiscal discipline among voters has encouraged governments in both countries to stick scrupulously to rules designed to avoid deficits and reduce debt.
As Switzerland and Germany are open economies, and thus highly exposed to trade uncertainties and the global slowdown, the critics say that now is the time to use the considerable fiscal space that both countries have built up to exploit historically low interest rates. The longer the weakness in manufacturing lasts, the higher the chance it spills over into domestic demand, the main pillar of growth. Beyond short-term considerations, there is a longer-term need in both countries to tackle structural issues.
In recent weeks, the German grand coalition has agreed on a package of measures to combat climate change amounting to EUR54bn up to 2023. However, the package has disappointed some observers, not least because the government intends to stick to its balanced budget target.Our longstanding view remains unchanged: for Berlin to launch a major fiscal package will require a significant deterioration (not just a technical recession) in the German economy. We are not yet there, but we are seeing some cracks. Amid the ongoing contraction in manufacturing and trade, the resilience of domestic demand is preventing the economy from slipping into a more severe downturn. The health of the labour market will be decisive. An external shock such as a no-deal Brexit or US auto tariffs could also prompt a policy response. So could a snap general election. The contest for leadership of the centre-left social democratic party (SPD) this autumn will be important in this regard.
If Germany finally decides to loosen its belt, we believe that measures will likely be precisely targeted and exclude sectors like construction that are showing signs of overheating because of low interest rates.