Macro Meets Sustainability
Is fiscal policy now the dominant tool for business cycle management?
Given the connection between fiscal policy and voters, what role does understanding voter preferences have on investment returns?
What are the implications of fiscal policy becoming a more important business cycle lever with respect to environmental and social (sustainability) themes?
Over the past three decades, central bankers have ensured a certain market stability for investors by regulating the business cycle via interest rates. Although interest rate policy is far from dead in investor’s minds, current and future environmental and social challenges can’t be tackled simply through altering the cost of money. We believe the consequent shift to fiscal as the dominant policy force is already underway and this transition carries significant investment implications that will take sustainability factors from a niche investing theme to a powerful driver of cross-asset returns.
Monetary Policy Dominance: The End of an Era
The pivotal moment for monetary policy came in 1979 when Paul Volcker tamed runaway inflation, propelling monetary policymakers to prominence. For three decades, business cycle management revolved around adjusting interest rate levels, and was successful (for the most part) in generating economic growth while ensuring price stability.
However, since the Great Recession, it has become increasingly clear that monetary policy is not enough. The economic challenges of today – rising inequality, outsourcing of jobs to automation, access to water and other natural resources – are not responsive to adjustments in the level of interest rates.
Enter Fiscal Policy
We posit that fiscal policy stepped into the spotlight in the policy toolbox around 2015. Following a brief interruption during Trump’s tenure, fiscal has been revived by the Biden administration (see chart). As fiscal policy is increasingly deployed to manage business cycles, investors will need to pay greater attention to the implications of taxation, spending, and regulation.
Precision Tool vs. Blunt Object
In comparison to fiscal policy, monetary policy is a blunt tool. The greater precision of fiscal policy has important implications for financial markets and investors. Since fiscal policy targets specific areas of the economy, it’s progress can be measured in a variety of ways. This will result in greater price dispersion across companies and industries creating distinct winners and losers. With elected officials becoming the dominant policymakers, voter sentiment becomes a barometer for identifying these winners and losers. Afterall, politicians who address voter concerns in their policy decisions should benefit from stronger re-election prospects.
FINAL THOUGHTS
So, what are voters thinking, (the million-dollar question!)? At the expense of worries over economic growth, environmental concerns are gaining prominence as a top priority (see chart) and social issues like health care, education and fairer wages are also making headlines. Sustainability themes, once niche, will become major drivers of investment strategies. We have already seen the influence of the (union friendly) Biden administration’s Inflation Reduction Act in certain segments of the market.
This shift from the multi-decade era of monetary policy dominance to fiscal policy, a more precise economic tool, offers a chance to address top priorities among voters. Investors should brace for a direct link between voters’ concerns, policymakers and economic outcomes that shape market trends and returns. As a reflection of the top voter concerns, opportunities in sustainability themes will continue to abound.