U.S. Fiscal Stimulus and China’s Response

  Macroeconomic policies in the epidemic response

  Played an important role

  In the aftermath of the outbreak, economies have adopted large macro stimulus policies, including fiscal and monetary policies.

  After the outbreak, the IMF launched Policy Tracker, a data system that summarizes and calculates fiscal and monetary policy bailouts advertised by countries to facilitate global comparisons of stimulus efforts across countries; the data in Policy Tracker may not be accurate, for example, the IMF’s estimates of fiscal and monetary policy stimulus in China are low.

  Among the G20 countries, the top 8 countries in terms of fiscal stimulus are all developed countries, and the bottom 12 are emerging markets.

  In terms of monetary policy, compared to a year and a half ago, policy rates have fallen significantly in all countries, but monetary easing is stronger in developed economies than in emerging markets. In Figure 2, Argentina is well outside the chart, but its policy rate has also fallen to 32.0% from 53.7% before the crisis.

Fiscal policy in the United States is strong.

  Last year under the Trump administration about $3.6 trillion or so, this year the Biden administration took office and is expected to introduce four plans. the size of the bailout plan already introduced in March is $1.9 trillion, the jobs and tax plan under discussion is expected to be $2.2-2.3 trillion, and the upcoming family plan market is expected to exceed $1 trillion, for a total fiscal stimulus of $7-8 trillion. Of these, the jobs and tax plans are likely to be discounted, with the Biden administration’s proposal for $2.3 trillion in investments and the U.S. Senate Republican proposal for a hedging program of only $600-800 billion. Nevertheless, the overall U.S. fiscal stimulus is still very large.

  On the tax front, in addition to tax increases, the U.S. is recently pushing for the lowest corporate income tax rate in the world, which has been hotly debated by all sectors.

  The global minimum tax rate is proposed in the context of the G20 Digital Tax, which has two main pillars: the first is the “tax linkage” and the second is the global minimum corporate income tax rate.

  The “tax nexus” under the current tax rules is based on whether a business has an entity in a country. In the past 10 years, Internet platform companies and the digital economy have grown rapidly, and some EU countries have argued for the taxation of digital economy activities.

  In 2019, the G20 commissioned the OECD to study digital taxation, and the OECD proposed a “two-pillar approach” to digital taxation. Pillar 1 is the expansion of the “tax linkage” rule to clarify the scope of corporate income tax, tax calculation and allocation in the context of the digital economy. Pillar 2 is the lowest corporate income tax rate in the world, which is an expansion of the OECD’s ongoing efforts against “tax havens”.

  At present, the main differences between the EU and the US are in favor of reform.

  The EU, based on the British program, adopts a user participation program, covering social media, search engines, online trading platforms, the host country can be taxed on large technology companies. A company is not a British company, but as long as the above activities are carried out in the UK, the UK government has the right to collect taxes.

  And large technology companies are mainly American companies. Whereas 5-6 years ago the US accounted for 7 or 8 of the top 10 internet companies, now about 5 of the top 20 are Chinese companies and the remaining 15 are US companies. The U.S. feels it is being targeted and therefore tit-for-tat proposes marketing-based intangibles.

  The U.S. side argues that although some traditional multinationals do not engage in digital economy activities, brands also use the Internet for sales and such intangible assets should be included in the taxation. For example, French brands such as Chanel and Dior, U.S. users or consumers can also obtain products through online purchases, and these online shopping activities invariably add user information for Chanel and Dior to launch products for the U.S. market. Therefore, the U.S. believes that marketing intangibles such as trademarks should also be taxed, substantially expanding the concept of tax nexus.

  In addition, India asserts a significant economic presence, similar to the UK. Although the other party does not have a presence in India, there is a significant amount of customer involvement and in effect a significant economic presence. Both the EU and Indian proposals were aimed at large technology companies, and the U.S., in an effort to muddy the waters, especially during Trump’s presidency, expanded the concept from large technology companies to all traditional multinational corporations. The so-called lowest corporate income tax rate in the world is now actually for multinational companies.

  After Biden took office, the U.S. government shifted its philosophy and went multilateralist in its negotiations, but raised the asking price substantially. The original minimum corporate income tax rate proposed by Europe is 12.5%, but now the United States has raised it to 21%.

  The U.S. is now promoting the lowest corporate income tax rate in the world, which is “three birds with one stone”. First, to solve the past four years of disputes with the EU; second, to protect the interests of their large technology companies, the tax will be extended to other countries multinational corporations; third, the traditional OECD concept to combat tax avoidance. Is this matter related to the big fiscal stimulus? It may be somewhat related, but it is more the result of years of strife over the digital tax.

  The Impact of U.S. Active Fiscal Policy

  There are four interesting recent debates about the impact of active fiscal policy in the United States.

  The first is the debate between high-pressure economics and traditional economics.

  Traditional economics argues that the current fiscal stimulus is so strong that the deficit has expanded to $2 trillion, the interest burden is getting heavier, and eventually the U.S. economy will be overwhelmed.

  But high-pressure economics argues that crises like the epidemic are extremely damaging to the real economy and have a greater scarring effect. If we want to bring the economy back to pre-crisis levels, we need a big stimulus to bring the economy to a state of relative overheating and pull the stagnant economy from the trough to above the average in order to promote employment for low-income people and enable everyone to enjoy the dividends of development. Relative contraction after overheating is better than too little stimulus to allow the economy to return to its pre-crisis state and heal the scarring effect.

  U.S. fiscal policy is practicing high-pressure economics.

  At the beginning of the year, former U.S. Treasury Secretary Summers and former IMF chief economist Blanchard uphold the traditional philosophy that the size of the U.S. fiscal bailout is too large, which may lead to a substantial overheating of the economy and bring greater inflationary pressure. While Yellen said that the stimulus package will not bring a surge in inflation, even if there are sufficient tools to deal with it; Krugman also believes that economic overheating may not lead to inflation.

  As an aside, it is not so easy to say whether it will inevitably lead to inflation, but some U.S. economic policy makers believe that even if there is inflation, it seems to be better than prolonged economic stagnation or failure to come out of the bottom.

  The second is the heated debate over the comparison of fiscal bailout models between the U.S. and the EU.

  One is the size of the fiscal effort.

  The U.S. side believes that the U.S. economic recovery is clearly stronger than the EU, the economic outlook is better, has come out of the trough, and the engine of global economic recovery from 2021 will be in the United States. The reason why Europe’s economic recovery prospects are not good enough is because the fiscal stimulus is small.

  This has caused a series of officials in the eurozone to retort with discontent. In terms of fiscal spending, the EU is significantly smaller than the United States. But the EU fiscal provided loan guarantees as a proportion of GDP is significantly higher than the United States, the EU through fiscal guarantees, stimulating the operation of financial markets, stimulating economic recovery, may not need fiscal direct spending so much money.

  Overall, the difference between the U.S. and Eurozone fiscal deficits as a share of GDP is not significant in terms of growth. Second, due to the complexity of adding up the data, the current comparison of the data is at the EU level and does not fully account for the fiscal stimulus efforts of the EU member countries. The debate between the U.S. and the EU also objectively reflects that the strength of the U.S. fiscal stimulus is indeed relatively large.

Second, in the process of financial assistance, should we “subsidize enterprises” or “subsidize individuals”? Which is better?

  In the United States, direct subsidies to individuals and families account for 30% of the fiscal measures, while wage protection programs that “subsidize enterprises” account for only 15%. In contrast, Europe mainly subsidizes enterprises, with job retention programs accounting for 25% and direct subsidies to individuals accounting for less than 8%.

  The U.S. believes that subsidizing enterprises may cause the problem of zombie enterprises, and once the EU fiscal bailout measures are withdrawn, the bankruptcy of small and medium-sized enterprises will intensify, which is also an issue of lively discussion in the international community. As for the way the U.S. subsidizes individuals, the EU believes that unemployment will increase if subsidies are stopped in the future. But the U.S. believes that this may be more conducive to labor market flexibility, so that the labor market remains somewhat resilient.

  Third, the choice of bailout measures and stimulus measures.

  Europe is more self-sufficient in this regard, in the long-term budget of 1.1 trillion euros introduced at the end of last year, the EU has allocated funds to support the digital economy and green transformation, which is conducive to improving the resilience of economic growth in the medium and long term. The United States, on the other hand, is focused on bailouts and only in March this year proposed to expand infrastructure investment.

  The third is the debate over the rising sovereign debt exposure of commercial banks.

  After countries increased fiscal stimulus, the supply of treasury bonds increased, and commercial banks bought a large number of countries’ treasury bonds, and sovereign debt exposure rose.

  Italy, Spain, Portugal and other countries that have experienced the European debt crisis now have about 20% of their sovereign debt held by their commercial banks. the fastest growing commercial bank sovereign debt exposure in 2020 was Greece, up nearly 60% year-over-year, and the U.S. also up 28% year-over-year. While the U.S. does not have a high percentage of sovereign holdings by commercial banks, the rapid growth rate has caused concern among regulatory authorities. Japan’s commercial bank sovereign debt exposure is growing relatively slowly, but traditionally the Bank of Japan holds more government bonds, and commercial bank holdings are instead smaller than the central bank.

  Treasury holdings are also growing rapidly in emerging market economies. 12 major emerging market economies have seen commercial banks purchase more than 60% of their country’s new sovereign debt issuance.

  Now the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) are starting to discuss whether the increasing exposure of commercial banks to sovereign debt will cause a situation similar to the European debt crisis. Increased sovereign exposure leads to increased bank risk, which curbs bank balance sheets and affects financial stability.

The fourth contention is the increased volatility in financial markets.

  Long-end U.S. interest rates have moved higher, with the 10-year Treasury yield once exceeding 1.7% and recently falling below 1.6%. The market believes that the main reasons for this include rising inflation expectations and higher real interest rates. Another important reason is the increase in the supply of treasury bonds and the decline in demand.

  Coordination of fiscal policy and monetary policy

  Since this round of the epidemic, U.S. fiscal and monetary policies have been coordinated with each other. Fiscal policy has been very active and monetary policy has been relatively strong, both in terms of keeping total liquidity ample and enhancing targeted support.

  The 10 major liquidity relief tools introduced by the Federal Reserve have sent stabilizing signals to the market and boosted market confidence. The cooperation of fiscal and monetary policy is reflected in the fact that, among the 10 major policy tools introduced by the central bank, the U.S. Treasury provided 215 billion in equity funds or credit guarantees to seven of them to help the central bank share the risk and absorb losses.

Why do central bank bailouts need fiscal capital protection and risk sharing?

  First, the commonality of fiscal policy across countries is the flow management of the budget, which keeps cycling back and forth from year to year. Second, fiscal policy generally requires authorization through Congress, political pressure is relatively small, and even if there are mistakes, the impact time is relatively short. In contrast, monetary policy involves independent balance sheet management by the central bank, and the risks and losses incurred need to be absorbed by itself, and the impact on market liquidity and financial market stability is comprehensive, and the time required to absorb the policy impact is longer. If there are failures in monetary policy, the impact on the economy is medium to long-term, far-reaching and comprehensive.

  The side effects of prolonged monetary easing and large fiscal stimulus in the United States have already emerged.

  First, the potential for financial risk is breeding. In the past two months, the bankruptcy of Greensill, a supply chain financing company, triggered a chain reaction of financial institutions; Archegos Capital, an asset management company, burst its position, leading to a series of commercial banks to lose money. Credit Suisse was affected by both events, with losses said to be between $5-10 billion, which is alarming.

  Second, the issue of rising house prices. Canada, Australia and the UK are also starting to worry about home prices in their countries. So far this year, U.S. house prices have risen significantly, and the house price index has risen by more than 11% year-on-year, also as a side effect of long-term easing.

  Couldn’t a strong fiscal policy create some room for monetary policy exit?

  Powell has been saying that there will not be an exit before 2024, but in recent times the tone has changed. The first sentence is that the risk of exiting too early is greater than exiting too late, so you can not exit too early, and the Fed turns out not to consider exiting at all. The second sentence is that if the Fed wants to exit, it will certainly communicate fully with the relevant economies and markets to understand the spillover effects of the Fed’s exit on the global economy and will be very cautious. Two other policies recently introduced by the Fed are the removal in March of the policy exemption introduced last year for commercial banks to supplement their leverage ratios, and the raising of the overnight reverse repo ceiling. In my view, there has been a subtle change in the Fed’s external stance and it has started to consider the exit of monetary policy.

  In addition, emerging market economies have recently started to raise interest rates ahead of schedule. on April 23, Russia surprised the market with another 50 basis point rate hike, accompanied by a lengthy statement from the governor of the Russian central bank, talking in particular about the impact of the global economy, global liquidity on Russia’s exchange rate and capital flows. Brazil and Turkey have also raised interest rates ahead of schedule, mainly in response to domestic inflation with precautionary rate hikes and pressure to depreciate their currencies.