The results of the Canadian election this week were quite a surprise. Justin Trudeau’s Liberal party had a majority victory over the Conservative Party that had led the country for almost a decade. The new government is expected to cut taxes for middle-class households while raising taxes on the top 1% earners. It has also pledged to spend an additional $60 billion (Canadian dollars) on infrastructure projects to spur growth.
The market initially reacted by buying the Canadian Dollar, since a new government encouraging more fiscal stimulus would defer any immediate need for monetary easing. However, that trend quickly turned around when the Bank of Canada lowered their economic forecast the next day.
While the market is still digesting the news, the election result seems to have sparked a new theme in the financial market; a gradual shift away from monetary stimulus and more focus on fiscal policies.
The massive amount of monetary stimuli provided by central banks around the world since the Great Depression of 2008 has been successful in avoiding deflation but not in stimulating growth. Even with super low interest rates and a lot of cash at hand, you cannot force people to keep on borrowing and spending money; in fact people seem to be doing the opposite which is deleveraging and holding on to cash. So there are limitations to monetary policies.
Meanwhile during the period of extremely loose monetary policy, most governments had focused on maintaining fiscal discipline and tightening their purse strings. Canada (and Harper’s Conservative government) was the top performer, achieving a balanced budget even when oil revenues were declining. But that wasn’t good enough for the Canadian people and with this election, they are clearly saying they want the government to do more direct spending to rebalance their economy into more non commodity-driven industries, rectifying the imbalances and to spur growth. Could this happen in other countries?
My View: Recently notable economists and policy makers have pointed out that central banks cannot rescue economies and that government needs to do more. This is certainly more challenging as it could go against fiscal discipline. As far as the market goes, it is also less transparent for investors to respond to fiscal policy changes compared to monetary policies. Consequently, we may see a period of lower volatility where the market is no longer one-sided.
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