Fiscal space: a mix of macro, exchange rate and monetary policy

As monetary policy is largely exhausted, economies will need to rely more on fiscal policy to absorb shocks. Germany and the US have ample fiscal space, while Italy is more constrained. Longer-term, thinner fiscal buffers can ultimately hurt insurers' premium growth and asset portfolios.

We believe that fiscal policy will be a key instrument to mitigate future economic shocks in advanced markets as monetary policy options are largely exhausted. Yet, the ability to action fiscal stimulus depends on the room of manoeuvre that economies have (what we term "fiscal space"). Importantly, fiscal space is about more than just fiscal: it's a mix of macro variables, the exchange rate and monetary policy. In fact, weaker fiscal positions can be supported for a while in "non-crisis" times by loose monetary policy, creating fiscal space that otherwise likely would not have been available. Overall, the euro area remains more exposed to an economic or sentiment shock than North America.

Key takeaways

  • Fiscal policy will be a key instrument to absorb future shocks, but the ability to do so is not given
  • Market pressures matter a lot for fiscal distress. Structurally weaker fiscal positions can be supported for a while by loose monetary policy
  • The euro area sovereigns are more exposed to shocks as fiscal and monetary buffers are thinner than for example in North America
  • Re/insurers should closely follow these developments as they can affect premium growth and asset portfolios

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