Can fiscal policy push prices lower?

Posted by: Paul Donovan

01 Apr 2021

Weekly Updates

  • Some investors think all of the fiscal response to the pandemic was a stimulus. This is not true. The fiscal response to the pandemic is a mix of stimulus and anti-depressant. Misunderstanding what fiscal policy has done fuels mistaken ideas about inflation risks.
  • Stimulus policies create economic activity that would not otherwise occur. For example, environmental sustainability initiatives are brand new spending, raising demand. Whether the stimulus is offset by fiscal tightening is important. For example, US President Biden’s infrastructure proposals are largely offset by proposed corporate tax increases, making the policy more redistributive than stimulative.
  • Most recent fiscal deficit increases have been anti-depressant. Anti-depressants are aimed at preventing growth from falling, rather than pushing growth higher. European furlough schemes and payments to US states tried to prevent growth from falling as pandemic restrictions were applied. Such policies fight deflation rather than promote inflation.
  • Some aspects of fiscal policy are likely to be disinflationary. Loan guarantees and grants to businesses aimed to keep firms afloat during pandemic restrictions. If these firms had failed, their capacity to supply would be missing when the economy bounces back. With fiscal help these firms stayed in business and are ready to increase supply to meet the increase in demand as restrictions lift, keeping inflation contained.

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