Arguably the biggest news in US capital markets last week came from outside our borders, in the form of European Central Bank President Mario Draghi’s dovish comments after a meeting of the ECB’s governing council.
Draghi strongly suggested that the ECB will get more accommodative, and although he was not specific on what tools he would use to do so, many expect the ECB to increase its quantitative easing program—perhaps as early as December. Investors cheered the news, sending stocks surging. That’s no surprise, given the impact that accommodative monetary policy on a global scale has had on stocks over the past few years.
But it’s easy to overlook that what the ECB is doing is actually historic. Consider that the ECB is just a youngster compared to the US Federal Reserve: The ECB was established in 1998, while the Fed is more than 100 years old. And yet just a few years after its founding, the ECB began to realize that it needed to follow the Fed’s playbook and flex its muscle in very significant and extraordinary ways.
It all started in the summer of 2012, when Draghi made a historic speech in which he pledged to “do whatever it takes” to support the euro-zone economy. Yet even though the ECB was facing headwinds that the Fed wasn’t—its relative youth and inexperience, and its position in a monetary union without the benefit of a fiscal union, to name a few—markets viewed Draghi’s comments with credibility, and reacted accordingly. In fact, in the ensuing years, systemic stress in the euro zone dropped significantly despite several crises—including the situation surrounding Greece and its debt.
The ECB’s bold moves underscore what we’ve been saying for some time: In the absence of significant fiscal stimulus from lawmakers, economies must rely on monetary stimulus from central banks to spark growth. And the bigger, the better—at least for now. That’s why we’ve seen such positive market reactions in recent years to extremely accommodative policies from the Fed, the Bank of Japan and the ECB.
But it’s important to recognize that monetary policy can only go so far; it is a blunt instrument, not a surgical tool. Monetary stimulus can create conditions conducive to greater spending, but it can’t force that greater spending—just as you can lead a horse to water, but you can’t make it drink. That’s why, at some point, we’re likely to see voters demand more fiscal stimulus in the form of tax cuts or increased government spending. Done right, fiscal stimulus can be one of the best ways to actually get that economic horse to drink.
The shift in focus from monetary to fiscal stimulus might already be underway globally. Case in point: Justin Trudeau, who ran largely on a platform of greater fiscal stimulus, was elected just last week to be Canada’s next prime minister. It could also become an important theme in next year’s US elections. Consider that fiscal policy has actually been fairly non-stimulative in the US, working against the efforts of the Fed’s accommodative monetary policy. However, boosting fiscal stimulus is a particularly prickly topic for US lawmakers, given the imminent debate over the debt ceiling (note the postponement of last week’s 2-year Treasury note auction) and ongoing concerns about the high level of public debt in the US.
We certainly wouldn’t be surprised if some US voters begin to demand more fiscal stimulus, given that the jobs recovery still feels flawed even though headline unemployment is at 5.1%. One could make the argument that much of the unemployment below 5.1% is structural in nature, largely caused by all the innovation we’ve experienced—think of newspaper deliverers being displaced by news delivered digitally, or supermarket cashiers being replaced by self-serve checkout lanes. What we know about structural unemployment is that monetary stimulus can’t help it, but fiscal stimulus might be able to—especially policies that focus on job re-training.
Yet so far, the absence of fiscal stimulus in recent years has been felt around the world. While central banks continue to offer up significant monetary stimulus—the BOJ is expected to get more accommodative at its upcoming meeting this Friday—it may not ultimately prove to be enough for some electorates.
We could get a sense of where US fiscal policy is headed after we see how Congress handles the debt ceiling next week—and how the public reacts. And we’ll know where monetary policy in the US and Japan is headed after their central banks have meetings this week. Either way, the next few weeks will be telling.
Kristina Hooper is the US Investment Strategist and Head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law, a master's degree from Cornell University and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
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