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Medium-term inflation outlooks have risen higher than expected in recent months,1 and some believe the heavy spending programs deployed by governments such as the US to revive their economies could come at an unexpected cost.
“Those in favour of orthodox economic policy argue that when governments play a smaller role in economies, markets are more efficient at allocating resources,” says Newton Real Return Global Strategist Brendan Mulhern. “The same class believes that the greater role the government plays, the greater the cost to sustainable economic growth.”
During the pandemic, the US launched its Modern Monetary Theory (MMT) style policy. The Federal Reserve cut interest rates to zero and launched a quantitative easing (QE) program, purchasing US$80bn of Treasury securities and $40bn of agency mortgage-backed securities (MBA) each month.2 It then passed a US$1.9 trillion fiscal package called the American Rescue Plan, which included everything from US$1000+ checks for the public to US$350bn dollars for states and local governments.3
In turn, the European Central Bank (ECB) cut rates to record lows and debuted its own QE, the Pandemic Emergency Purchase Programme (PEPP). It then set out to purchase a total of €1,850bn in public and private sector debt by December 2022, at the earliest. On the fiscal side, the European Union unveiled a €750bn stimulus program titled NextGenerationEU, to be distributed among member states in the coming six years.
Commenting on these programs and the likely future shape of public spending, Mulhern says: “It’s unlikely that we’re going back to the days when governments subscribed to the idea of fiscal conservatism. It appears that the scale to which government deficits are growing and the increased role of governments in economics is trending upward.”
While governments have spent a lot of capital on Covid-19 stimulus packages, significant amounts of the money are being channelled into initiatives designed to help tackle climate change. In the US, an environmentally aware president, Joe Biden, is keen to address the net zero challenge.
According to a study in February, 10.6% of the $17.2 trillion in Covid-19 stimulus deployed by 30 major economies will have a net positive impact on the environment.4 The same study concluded that 17 countries, including the US and those within the European Union, have improved the “greenness” of their stimulus packages.
While the American Rescue Plan was largely focused on general economic recovery, US$30bn went to public transportation, whose renewal and upgrade could be essential to reducing the quantity of vehicle emissions.5 Other funding is being invested in communities impacted by the market-based transition to clean energy.6
Separately, in July the US Senate Committee approved the Energy Infrastructure Act, which would authorize over US$100bn to restore ecosystems and mitigate wildfire risks, among other initiatives, while provide funding for the Energy Act of 2020.7 The Energy Act of 2020 is to be dedicated to funding research and development (Ramp;D) for solar technologies, transportation technologies and recycling technologies.8
As for Europe, member states must use at least 37% of funds they receive via NextGenerationEU to protect the environment and a further 20% to digitize European economies.9 Amid a slew of initiatives, the capital is to be allocated throughout the Just Transition Fund, which targets regions that are heavily reliant on fossil fuels, aiming to reduce job disruption and economic impacts from a low-carbon world. It will also provide funding for renewable energy and storage, as well as rural development to decarbonize agriculture.
Most of the projects mentioned above come from Covid-19 stimulus plans, which governments are financing by monetizing fiscal deficits. This is when central banks print currency to accommodate deficit spending. But, given inflationary forecasts, could there be negative economic implications from this very spending?
“A reading of financial and economic history shows that the monetary financing of fiscal deficits is a necessary but not sufficient condition for a sustained acceleration of inflation,” Mulhern says. “As such it increases the probability that inflationary pressures will be higher through time.”
For all this, Mulhern adds that other factors may be of greater influence on rising inflation; for example, supply chain disruption, the roll back of globalization and reshoring jobs that were previously offshored in low-cost economies.
Either way, the jury is out on the exact pros and cons of heavy public spending on environmental initiatives and other areas versus the wider health of economies. Amid the twin challenges of climate change and inflationary pressures, only time will tell.
1 Bloomberg: Most ECB official See Upside Risk to Medium-Term Inflation. July 9, 2021.
2 S&P Global: Fed’s monthly bond purchases endure as economic, vaccination goals fall short. April 21, 2021.
3 National Conference of State Legislature: American Rescue Plan Act of 2021. March 2021.
4 Vivid Economics/Finance for Biodiversity Initiative: Majority of 17.2 trillion Covid Stimulus Packages “Doing more harm than good” to the environment. July 15, 2021.
5 The Atlantic: Biden’s Stimulus is a Big Deal for Public Transit. March 10, 2021.
6 The White House: President Biden Announces American Rescue Plan. January 20, 2021.
7 Nuclear Newswire: Senate Panel endorses energy infrastructure bill. July 15, 2021.
8 TechCrunch: New stimulus bill includes 35.2 billion for new energy initiative. December 2020.
9 Deutsche Welle: EU launches coronavirus stimulus program. June 23, 2021.
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