Despite varying responses to the pandemic, global recovery prospects are bright – however, public debt and inflation must be handled tactfully to best support this outcome, Robert Fauver asserts in this interview
How effective has the United States been in countering the recession caused by COVID-19?
Our economy is bouncing back very strongly. This was not a classic recession brought on by a lack of demand or gross over-inflation. The level of demand always remained strong, but was unable to be used. So it has been more a question of when to allow people to be free than what governments are doing to support the economy. Much of the first US stimulus package still has not been passed on to the people. So far it has largely been money passed to businesses to keep people employed. We will have a very strong V-shaped recovery. We will beat growth expectations this year, and we could have a very strong 2022.
But the Federal Reserve is continuing zero interest rates and flooding the market with cash. That, second only to excessive government spending, underlies the risk of inflation. If we pass the proposed $6 trillion new stimulus packages, you’ll have a huge injection of liquidity into the economy, with the danger of inflationary pressures, rising towards the end of 2021 and snuffing out the strength of the recovery in 2022.
Will other G7 members benefit from the US situation?
Psychologically it is the most important factor. Until production in Europe picks up, they won’t have the capacity for exports even though we might have the demand for their imports. So as we do better it will encourage Europeans to reopen. They are nowhere near along the path of regenerating hope that we are.
How effective are Japan’s efforts?
Japan’s horrendous problems have been caused by three factors: first, because of the Olympics, they withheld every effort to publicise their domestic COVID-19 challenges. Second, given the Japanese view of illness, it is part of their culture not to discuss their health. Third, the government has been confused about what to do and did not secure vaccines early enough. They are slowly getting started. They will lose a tonne of money on the Olympics, which will be a huge overhang on all of the tourism business.
How are Europe’s economic prospects and policies?
I am perhaps an outlier. I don’t think Europe will have the recovery in 2021 that was forecast by the International Monetary Fund. Europe will be lucky to see 2% growth this year. The Europeans are behind the curve in securing the vaccines that will allow them to reopen their economies. Tourism and business travel have come to a standstill. Their policies on the macroeconomic side have been okay. How long they hold their zero interest rates, we have yet to see. There will be some pressure, at least in Germany, to return to a firm monetary policy as inflation picks up from the commodity sector.
And the United Kingdom?
They have done better than expected. The Brits have done a superb job with vaccines. They are now pretty much reopened with some constraints, but further ahead by months. Their macroeconomic policies have been okay. I expect this year will be better than normal and next year above normal.
I expect around 5% growth this year and next. Canada will benefit from the US recovery, on energy and cross-border business. Lumber is skyrocketing so Western Canada will see huge increases in income. There have been some vaccine distribution issues, but I have no issue with Canada’s macroeconomic policies.
Are G7 members’ current fiscal and monetary policies the proper one?
No. We’ve flooded markets with liquidity in excess of what makes long-term sense. Most of the world has had zero interest rates for a significant time, pre-pandemic. Central banks’ build-up of assets from purchasing bonds and paper is phenomenal. Selling that back into markets will have major effects. We have run far looser for longer than is healthy.
So we should worry about rising inflation and interest rates?
For the first time since World War II, US federal debt is higher than gross domestic product. I’m a huge critic of large national debt. After the 2008 financial crisis we took to task our European friends who got out of line with their debt-to-GDP ratios. US national debt could crowd out spending.
Rising interest rates will help recoveries in general, because we need a positive yield curve, which has been relatively flat. A positive yield curve with longer term rates at 4% or 5% would strengthen long-term recovery, though with short-term dislocation effects. But raising interest rates by 1% on $20 trillion of debt has a huge effect on annual debt servicing costs. This will crowd out other spending unless you raise taxes, and in a recovery phase, raising taxes does not seem appropriate.
What should G7 leaders at Cornwall do to steer the recovery on to the optimal path?
They need to be cheerleaders. Many economies, including most G7 members, need positive, realistic encouragement. Building business and consumer confidence is important at this stage. If governments are over-optimistic, it will shake markets. So they have a difficult act to balance urgently needed optimism with long-term fiscal responsibility.