Welcome back. Every so often a chart lands in my inbox that puts a fresh perspective on how I interpret macroeconomic trends. This week, it was a time series of fiscal deficits in advanced economies going back three centuries.
Current struggles to rein in spending are well known. The long-run data, however, underscores how stark the problem is: large fiscal deficits, as a share of GDP, have been a fleeting feature across the rich world in periods of war — now they seem to persist in peacetime.
What explains this historical anomaly?
In this week’s newsletter, I outline how today’s persistent deficits reflect a broader normalisation of fiscal and monetary support in the aftermath of three major economic crises in quick succession.
In response to the financial crash, governments across the advanced world spent heavily to provide capital injections and loans. Central banks slashed interest rates and began quantitative easing.
Despite efforts to restrain spending in the following decade, when the pandemic hit, fiscal support returned: governments gave grants, loans and guarantees. Monetary policymakers expanded their asset purchase programmes. In 2022, following Russia’s invasion of Ukraine, European politicians cushioned the ensuing surge in energy prices with subsidies and cost-of-living payments.
Still, these large interventions do not entirely explain why there has been a continued downward drift in government balances over recent years, says Jim Reid, Deutsche Bank’s head of global macro research.
“It’s true that we’ve had some big shocks, but longer-term history shows that these events used to be followed by a push to balance budgets once growth returned,” says Reid. “The recent rise in deficits is largely a policy choice: there is little political appetite to get back to a budget surplus.”
Indeed, it is possible that quick, consecutive, once-in-a-generation shocks helped to normalise the role of economic support in propping up rich world economies. Here’s how:
First, governments now appear more ready and willing to extend support outside of significant crises.
Recent examples of subsidies and reliefs abound. They include Canada’s launching of a one-time grocery rebate in 2023; the Biden administration’s forgiving of $183.6bn in student loan debt; and, in June, the UK government’s unveiling of a £40 per megawatt hour subsidy for energy-intensive businesses in certain sectors, which will kick in from 2027.
This largesse extends to the financial sector, too. One prominent example followed the failure of Silicon Valley Bank in March 2023. The US Federal Reserve launched the highly generous Bank Term Funding Program, and guarantees were expanded to uninsured depositors.
The BTFP lent to banks, allowing them to pledge collateral at par. The scheme shored up the financial sector, but was criticised for providing excessive support for too long: over 1,800 institutions tapped it, and outstanding loans peaked at around $165bn before it was closed.
“The SVB support signalled that regulators were more afraid of the risk that they will be blamed for allowing a panic than they are of the consequences of putting huge amounts of federal resources at risk”, says Deborah Lucas, professor of finance at the Massachusetts Institute of Technology.
Second, repeated, large-scale monetary policy stimuli since the GFC have helped to establish a central bank backstop in financial markets.
“Expectations have certainly increased — the market knows there is a point where a slowdown will bring in Fed liquidity and/or lower rates”, says Steven Blitz, chief US economist at TS Lombard.
A May 2024 paper by John Cochrane and Amit Seru, senior fellows at the Hoover Institution, concurs. It argues that the expectation of central bank support whenever conditions deteriorate inflates stock prices, fuels leverage and, in turn, raises risks of a self-reinforcing monetary policy intervention and taxpayer-funded bailouts.
Central banks have also been cautious about unwinding their QE holdings too quickly, fearing market convulsions. This has left their balance sheets elevated, creating a structurally higher liquidity base in the financial system that props up valuations and market activity today.
Third, recent crises may have raised public expectations of what the state should provide.
For measure, in the US, net positive mentions of government support — covering welfare and protectionism — in Democratic and Republican party manifestos have trended higher since the early 1970s, based on calculations from the Manifesto Project’s database.
In particular, these mentions have surged since the GFC. This suggests politicians are increasingly pitching policies that extend state assistance to appeal to voters.
In the UK, the National Centre of Social Research reported in 2023 that expectations for government to keep prices under control, reduce income differences and provide industry with the help it needs to grow all reached a record, based on the British Social Attitudes survey.
Indeed, curbing support hasn’t been easy for governments either. Britain’s Labour party was forced to reverse over £5bn of planned cuts to welfare spending. French politicians are also struggling to agree on how to cut expenditure, given the inevitable pains on the public.
In sum, recent crises have helped to routinise — and sustain — government and central bank support.
At the same time, ageing demographics, poor health and national security are raising demands on the state.
Reid of Deutsche says that the combination of excessive fiscal and monetary support has, in turn, helped to avoid the pain of economic downturns. “It’s not a coincidence that some of the longest economic cycles have come in recent decades.”
“Historically, the risk of regular recessions has encouraged capital to be reallocated to its most productive uses”, says Reid. “But that’s been impeded by astonishing levels of support, which risk locking in inefficiencies to rich world economies.”
Many G7 deficit forecasts do not point to a significant budget consolidation in the coming years.
In the aftermath of three great shocks, every jolt might feel urgent. But cushioning endlessly erodes economic resilience, fuels dependence and entrenches deficits.
Policymakers ought to resist governing in permanent emergency mode. Hard choices may sting, but they spare the pain of rising debt, and the loss of even more economic dynamism in the future.
The long history of deficits casts today’s largesse in a harsher light.
Send your thoughts and rebuttals to [email protected] or on X @tejparikh90.
Food for thought
What happens when artificial intelligence-powered trading agents are released into simulated markets? This working paper finds that the bots collude with each other, fixing prices to make a collective profit.
Free Lunch on Sunday is edited by Harvey Nriapia
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