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Fiscal policy has proven to be the more critical support for economies during the initial lockdowns in spring 2020, compared with the global financial crisis in 2008 when governments relied more on monetary policy. This time governments in developed markets quickly deployed direct transfers to buffer household incomes as the global economy came to a screeching halt.

More fiscal stimulus is likely in the coming months and we expect additional $600bn of covid relief to be unlocked over the near-term on top of the approximately $900bn already signed off. Given the additional dose of fiscal stimulus, we now think that there is a strong chance that growth in the US in 2021 will exceed 7%, compared to the current consensus of 3.9%.

Recovery likely to be fitful

In Europe, new lockdowns to mitigate the second wave are capping the rebound from the first, and growth could be significantly negative in Q1. The US is likely to follow suit, given the worsening virus trajectory there. Further restrictions could hinder US economic momentum and make the global recovery fitful and unpredictable. 

Beyond Q1 2021, however, activity should rebound as restrictions are lifted, though much depends on how quickly and widely any potential vaccine(s) can be deployed and the start of vaccination programmes in various advanced economies has so far been slower than expectations. China remains an exception, as the government’s ability to contain the virus coupled with monetary and fiscal stimulus have already helped the economy to grow in 2020. 

We expect this growth to stabilise in China in 2021. Overall, we view risks to global growth forecasts (5.4%, according to the latest International Monetary Fund projections) as balanced, but remain alert to the risk of a near-term double-dip recession in the US. That said, arrival of additional fiscal stimulus has reduced the risk of a sustained downturn.  

Shift in the macro mindset: Austerity can wait

Continued fiscal policy activism is perhaps a very importance difference currently compared to the aftermath of the global financial crisis. The IMF has called for sustained fiscal support in 2021 and beyond (a reversal of the austerity it preached in the aftermath of the 2008/9 crisis).

Indeed, the IMF has called on developed market countries to take advantage of the low rates put in place by central banks and to continue to borrow heavily. It has also recommended boosting public consumption and investment programmes to support a recovery. The shift in ideology is significant, especially given the fact that the spending spree so far has already pushed developed market public debt ratios beyond those seen after World War Two. In emerging markets too, government spending is on the rise.

Economic theory offers three ways to reduce debt burdens: 1) disruptive de-leveraging as happened during the Great Depression, 2) high inflation and 3) high nominal growth generated by stronger real growth. In our view, how the high debt load is managed will remain one of the biggest macro drivers of global economic progress and the policy cycle in the coming quarters.

Salman Ahmed of Fidelity International. Handout photo
Salman Ahmed of Fidelity International. Handout photo

Central banks likely to keep policy very easy despite fiscal-led rebound 

The jury is still out on how inflation will develop in 2021, but cyclical inflationary risks have certainly risen to the upside given the changing picture on the fiscal policy front. We expect the major DM central banks to keep policy easy or easier despite any fiscal and vaccine led growth and inflation rebound during the second half of 2021. The Fed has already noted that “substantial” progress on both unemployment and inflation will be needed before any roll-back of the current QE programs take place, whilst the ECB has committed to providing additional easing throughout 2021 and beyond. Looking past the cyclical realities connected with inflation and unemployment we believe that the very heavy debt burdens (which are now exceeding WW2 levels in the DM world) would need extremely negative real rates to persist for an extended period of time driven by central bank policies.   

Regaining debt sustainability 

In the medium term, the recovery will depend on how well the sharp expansion of debt to deal with the covid crisis is managed and which path countries take towards debt sustainability (voluntarily or involuntarily). 

Many of the transformational changes in macro policy and economic models triggered by the covid crisis are yet to play out, including how we deal with the even bigger threat of climate change. In that context, the elephant has only just entered the room.

Salman Ahmed is global head of macro and strategic allocation at Fidelity International