Since the Financial Crisis of 2008, global authorities have relied on monetary policy – specifically lower interest rates and expanded money supplies – to boost aggregate demand, sustain economic growth and prevent the slide into deflation, with fiscal policy largely constrained in the face of increasing budget deficits and stocks of public debt.
However, many commentators have attributed the UK’s surprise vote to leave the European Union, and the equally unexpected victory of Donald Trump in the United States, to the failure of monetary policy to boost incomes amongst the lowest earners and the consequent persistence of inequality. This has fermented the idea, perpetuated by both Donald Trump and Nigel Farage, that politicians were ‘out of touch’ with working men and women, and part of a ‘liberal, metropolitan elite,’ unconcerned and oblivious to the wants and desires of the people that voted for them.
Voter dissatisfaction with the consensus suggests change is indeed coming, with fiscal policy likely to play an increasingly important role throughout the developed World. This should be encouraging for DB pension schemes.
Policy actions
In the UK, Chancellor Philip Hammond has abolished the strict deficit targets of his predecessor, allowing the government to cut taxes and increase spending. His promise to develop an industrial strategy – something which consecutive Conservative and Labour governments have lacked for decades – also promises to boost growth which, when matched with targeted infrastructure spending, could also serve to narrow the inequality divide. Public infrastructure not only increases economic growth by boosting aggregate demand, but also supports improvements to productivity and economic efficiency due to increased aggregate supply. The multiplier effect also ensures the benefits of the initial expense are transmitted throughout the economy; furthermore, with borrowing costs low, financing the increased budget deficit remains sustainable.
The election of Donald Trump in the States also promises to herald a new period of fiscal stimulus, with infrastructure and defence spending likely to see significant increases in the coming year. His commitment to cut taxes also supports increased economic growth, although the kind of tax cuts the President and his
Republican colleagues in Congress are likely to enact are not those necessarily aimed at the lowest paid.
Impact on investments
Looser fiscal policy is likely to have a positive effect on equity prices relative to fixed income securities; defensive sectors such as Consumer Staples, Utilities and Healthcare are likely to underperform, with cyclical sectors performing better.
Increased government spending and lower taxes boost discretionary income, which thus boosts consumer spending; not only does this support inflation but, more importantly, it also increases inflation expectations, which is what the monetary authorities monitor when making their policy prescriptions. Higher inflation expectations will compel Central Banks to raise interest rates, negatively impacting government bonds and other fixed income securities, particularly those of long durations.
While the last few years have been torrid for DB pension schemes, the promise of higher inflation and higher interest rates suggests that, despite all the shocks that 2016 has given rise to, 2017 could finally herald brighter prospects.
Matthew Tucker