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Article07 Sep 2021

Is the Global Economy Approaching a Fiscal Cliff?

With fiscal policy set to tighten in the next year in advanced and emerging economies, discussion is growing about the possibility of a looming fiscal cliff for the global economy. A new report from Citi’s Research Economist Igor Cesarec, summarized here, takes a nuanced view—pointing to sizable spending plans in the pipeline in several large economies, with robust tax revenues opening up the possibility of additional spending without jeopardizing fiscal space.

Fiscal policy is set to tighten next year and beyond, particularly in advanced economies, after being extremely accommodative throughout the pandemic, not only in 2020 but also in 2021.

AE and EM Cyclically Adjusted Primary Balance

Revisions to Global Fiscal Balance Forecasts

Source: Citi Research, Macrobond

Source: Citi Research

The tightening will likely be sharper in AE than EM, though policy was looser there to start with, according to Citi's economists. While fiscal policy is currently expected to be somewhat less tight in 2022 than anticipated earlier this year, Citi's Economics team notes that it is not wholly surprising that the fiscal stance will likely become less accommodative going forward given that the global economy continues on the path to recovery.

Does that mean government spending will dry up?

In the United States, a bipartisan infrastructure bill is currently moving through Congress. Even though its size has been stripped to $550 billion of new spending from $2.6 trillion in the initial proposal, it will likely be supplemented by another spending bill with a proposed price tag of $3.5tn passed along party lines through the reconciliation process.

In Europe, national recovery plans that will draw upon the €750bn in NextGenEU funds are under way with disbursements that look front loaded into 2022/23, with some risks of delays into 2023/24. Citi's economists expect the headline number to be an upper bound, with actual spending will likely to be lower, as some countries are reluctant to tap into the loan portion of the plan. However, the program should still provide positive fiscal impulse. These spending plans have the potential to support growth and create jobs in the coming years.

Robust tax revenues are playing an important role in improving budget deficits. In Germany, government tax revenue is now 12.2% above the July 2019 level, surpassing pre-pandemic levels for the first time. In South Korea, fiscal revenue year to date has grown at a historic 32% YY. Strong revenues open up the possibility of additional spending. Better-than-expected revenue numbers have also improved the immediate fiscal space in Brazil, but additional spending pressure is possible over the medium term.

Political outcomes will be a key determinant of future of fiscal policy. In Germany, for example, the shape of fiscal policy going forward will heavily depend on the outcome of the election in late September. CDU/CSU and FDP pledge tax cuts, while SPD and Greens are backing tax-funded spending increases. However, large-scale deficit spending is unlikely in any coalition, as the hurdle for changes to the constitutional debt brake remains high.

For more on this subject, please see the reports contained in the links embedded above and read the full report on the fiscal cliff, published on August 26, 2021, here: Global Economics Weekly - Fiscal Cliff on the Horizon?.

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.

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