As long as governments maintain public confidence the ratings impact of unconventional fiscal and monetary policies is, at best, neutral for countries that benefit from high levels of public trust and solidarity, says Moody’s Investors Services.

However, it cautions that a potential erosion of this public support would limit governments’ ability to stimulate their economies.

In a research note, Moody’s addresses potential concerns among investors as to whether this unusual “policy activism” is increasing the likelihood and precocity of a durable economic rebound, or whether, conversely, policymakers are in fact taking imprudent risks with public finances, thereby weakening sovereign creditworthiness.
“In effect, the economic policies of many advanced countries are now in ‘unknown territory’,” explains Pierre Cailleteau, team managing director of Moody’s Sovereign Risk Group.

“In Moody’s view, the answer to these questions depends — rather disconcertingly — on two potentially unstable notions: continued public trust in government institutions, including the currency, and sustained inter-generational solidarity mechanisms,” says Cailleteau.

Governments of highly advanced economies, where this public trust is strong enough, face only very remote limits to their ability to stimulate the economy through fiscal and monetary policies. “Unconventional policies will typically lead to very conventional outcomes — namely, more taxes and/or greater inflation,” adds Cailleteau.

In general, it notes, governments can raise, roll over and eventually pay off their debt almost without limit. “However, an erosion in the trust of the public and financial markets in institutions would limit these options, thereby exposing governments to roll-over risk,” cautions Arnaud Mares, senior vice president in Moody’s Sovereign Risk Group and co-author of the report.

Moody’s concludes that governments’ unconventional policies are defensive responses that are — at best — ratings-neutral if they succeed in kick-starting economic activity. However, if they lead to massive increases in public net debt and a permanent deterioration of debt affordability without tangible growth effects, Moody’s cautions that they will be ratings-negative. “In extremis, since confidence is not a linear process, these policies could potentially increase ‘tail risk’, and therefore also the (currently small) risk of sharp rating migration,” it warns.

IE