The New Fiscal Reality

PARIS – “When the facts change, I change my mind. What do you do, sir?” This, reportedly, is how Keynes replied to the criticism that he had changed his position on the policy response to the Great Depression. Pragmatism of this sort is not that common: policy views are often characterized by considerable inertia. Too frequently, today’s perspectives remain shaped by yesterday’s facts.

Fiscal policy is a case in point. Facts have changed in two significant ways. First, for sovereign states long-term borrowing costs are exceptionally low. At end-October, the annual yield for government bonds issued by France, a country with public debt approaching 100% of GDP, was 0.5% for ten-year bonds and 1.6% for 50-year bonds. Italy and Spain, both of which faced investors’ reluctance five years ago, have also been able to tap the market for 50-year bonds. As long as high demand for government debt securities lasts (a subject of debate among economists), it offers an unprecedented opportunity to finance public investment.

A key factor in determining whether to borrow is the difference between the rate of nominal GDP growth and the interest rate: if it is negative, debt can easily be repaid, because nominal income grows faster than the interest burden. Using the (fairly miserable) past as a yardstick, it is hard to believe that French nominal GDP will increase by less than 0.5% annually over the next ten years: from 2005 to 2015, nominal growth averaged 2.1%. So low interest rates are an opportunity that should not be missed.

The second way facts have changed is that output growth has been disappointing. In its latest World Economic Outlook, the International Monetary Fund noted that, despite the drop in oil prices and favorable monetary conditions, output and investment in advanced countries have consistently remained below expectations over the last two years. The outlook for the eurozone is especially underwhelming: the IMF expects output growth to slow from 2% in 2015 to 1.7% in 2016 and 1.5% in 2017.