In contrast to the financial crisis, fiscal policy has also been affected by the COVID-19 pandemic. Governments around the world have put together massive aid packages to provide companies with sufficient liquidity and reduce the wage losses of employees. This was urgently needed to counteract the global recession, but as a result, the already high levels of national debt in many countries look set to skyrocket at an unprecedented rate. The International Monetary Fund estimates that the increase in global public debt in 2020 will be more than six times that of last year.
It will be important to consider how governments intend to reduce their debt, although this will probably vary from country to country. We believe a combination of the following two mechanisms is likely:
Financial repression: We expect central banks to continue purchasing large amounts of government bonds, meaning a large part of the new debt of states will end up on central bank balance sheets, where it will remain. As a result, interest rates will stay low and investors will increasingly have to shift into risky assets in order to achieve higher yields. As in recent years, the liquidity provided by central banks will remain an important support for risky assets such as equities or corporate bonds, but in the long run, it also holds the potential for higher inflation rates. As inflation rises, the debt burden is reduced, meaning it is basically in the interest of governments that inflation increases. However, this is not something that can be managed directly and without collateral damage. Accordingly, in view of the strongly deflationary developments we are currently seeing, we regard a sharp rise in inflation as unlikely. However, the acceleration of protectionism (see Trend 2) should cause inflation to rise again somewhat in the longer term.
Tax increases: We consider the likelihood of industry-specific tax adjustments to be high, since proposals for environmental taxes and higher contributions from IT companies were already on the agenda before the COVID-19 crisis. The European Commission’s proposal for the EU-wide aid package, for example, is intended not only to support construction but also to be an investment in the future, as part of the Next Generation EU. In particular, the plan is intended to support the European Green Deal and digitisation. In principle, tax increases are poison for growth dynamics, which is why they should only be tackled once the economic situation has stabilised sufficiently.