Fiscal "Championship": Who is more proactive, the US, Europe, or Japan?

Abstract

After 2020, the industrial policies of the US, Europe, and Japan have made a comeback, ushering in an era of proactive fiscal expansion. The strength of fiscal policies directly determines the economic strength of the US, Europe, and Japan. Next year, the US, Europe, and Japan may face a new round of collective fiscal expansion. How will broader fiscal policies impact the economic landscape next year?

Hot Topic: Fiscal "Championship": Who is More Proactive, the US, Europe, or Japan?

(1) The Comeback of Industrial Policies in the US, Europe, and Japan: The Era of Proactive Fiscal Expansion

The fiscal positioning of the US, Europe, and Japan has shifted, no longer content with the past passive role of a cyclical stabilizer, and the proactivity of fiscal policies has strengthened. Due to the high proportion of welfare expenditures in developed economies, fiscal policy previously only played a stabilizing role. However, after 2020, the application of industrial policies in the US, Europe, and Japan has become more proactive, focusing on sectors such as semiconductors and defense, with a stronger willingness to guide the economy.

The fiscal rules in the US, Europe, and Japan have become more flexible, with Western political parties showing increased tolerance for high deficits. The differences in attitudes towards fiscal deficits between the two major parties in the US are narrowing, with both parties showing greater tolerance for expansive fiscal policies; Japan has repeatedly postponed its target for a primary budget surplus. European fiscal discipline rules have become more flexible, shifting from strict rules to a "rules + flexibility" approach.

The strengthening role of fiscal policy has led to the economic landscape being determined by the degree of fiscal looseness in recent years. From 2019 to 2025, the average deficit rate of major global economies is positively correlated with GDP growth; the higher the deficit, the higher the GDP growth. The US has benefited the most from expansive fiscal policies, with GDP growth from 2019 to 2023 exceeding that of the EU by 4 percentage points, primarily due to stronger fiscal stimulus.

(2) Fiscal "Championship": The "Resonance" of Expansive Fiscal Policies in the US, Europe, and Japan

The US, through the Inflation Reduction Act, will extend and expand tax cuts and increase defense spending next year. The US will significantly increase fiscal spending in defense and immigration enforcement, restore four corporate capital expenditure accelerators, which may slightly boost US capital expenditures; traditional industries such as fossil fuels and military industries, as well as capital-intensive sectors, will benefit the most. It is expected that the US deficit rate may expand to around 7% next year.

Europe's fiscal stance has overall shifted towards expansion, increasing spending on defense, infrastructure, and clean energy. Driven by security concerns, the EU's overall fiscal stance has turned expansive, launching defense expansion plans; Germany's fiscal stance has become more relaxed, including easing debt brake rules and establishing a special fund of €500 billion, of which €300 billion will be direct federal investment and €100 billion will be injected into climate transition funds.

Japan is expanding defense spending, normalizing inflation subsidies, and next year's fiscal budget is expected to reach a new high. After the July 2025 Senate elections, the ruling coalition in Japan may lose its majority, potentially leading to a more relaxed fiscal stance. For the fiscal year 2026, Japan's budget is expected to reach ¥122 trillion, marking a record high for the third consecutive year, with spending primarily directed towards defense, inflation subsidies, and energy transition.

(3) How Will Broader Fiscal Policies Impact Next Year's Economic Landscape? The US May Still Lead in Growth, While Germany May Improve Significantly Due to Fiscal Shifts

Next year's fiscal stance will shift from loose to tight in the following order: Germany, France, the United States, Japan, and the Eurozone. Germany's deficit rate increment is relatively high. In 2026, Germany's fiscal deficit rate is expected to expand by 0.5 percentage points, followed by France at 0.48 percentage points, the United States at an estimated 0.4 percentage points, Japan at a relatively low 0.23 percentage points, and the Eurozone showing a weaker overall increment due to internal differentiation.

Next year, the economic growth pattern for the US, Europe, and Japan is expected to be the US > Europe > Japan, with the US growth rate likely to remain ahead, but Germany's actual GDP growth rate may see a significant increase. In terms of the fiscal boost to the economy, the US is expected to contribute 0.6% next year, the Eurozone 0.2%, and Japan relatively weakly at only 0.1%. Overall, the GDP growth rates are projected to be 2.0% for the US, 1.2% for the Eurozone, and 0.5% for Japan next year. With the fiscal shift, Germany's GDP growth rate may improve significantly, potentially growing by 0.9% in 2026, compared to only 0.1% this year.

Report Body

After 2020, the era of proactive fiscal expansion in Western countries has arrived. The strength of fiscal policy directly determines the strength of the economy. Next year, the US, Europe, and Japan may usher in a new round of collective fiscal expansion; how will broader fiscal measures impact the economic landscape next year?

I. Hot Topic: The Fiscal "Championship" of the US, Europe, and Japan, Who is More Proactive?

(1) The Return of Industrial Policy in the US, Europe, and Japan, the Era of Proactive Fiscal Expansion Has Arrived

The return of industrial policy has made the "pro-cyclical" nature of fiscal policy in the US, Europe, and Japan more pronounced. In the fiscal expenditures of developed economies such as the US, Europe, and Japan, welfare expenditures account for a high proportion, with the US at 22%, Europe at 46%, and Japan at 30%. During recession periods, welfare expenditures such as unemployment insurance automatically increase, allowing fiscal policy to play a passive stabilizing role in the economy. However, after 2020, the use of industrial policy in developed economies like the US, Europe, and Japan has become more explicit, focusing on four key areas: semiconductors, clean energy, critical minerals, and defense. For example, the US has introduced the CHIPS Act and the Inflation Reduction Act, Europe has launched the EU version of the CHIPS Act, and Japan has introduced the 5G Promotion Act and the Green Transformation Promotion Act, indicating a strengthened willingness of Western countries to actively guide economic and industrial development through fiscal policy.

The fiscal rules of the US, Europe, and Japan are becoming more flexible, with an increasing tolerance for high deficits. In the US, the differences in attitudes towards fiscal deficits between the two parties are narrowing, and both parties are becoming more tolerant of loose fiscal policies. During the terms of Biden and Trump, the US leverage ratio has increased. Japan's target for a primary budget surplus has been repeatedly postponed; it was proposed in 2010 to achieve a primary fiscal surplus by 2020, but in 2018, the target was postponed to 2025. However, the budget for the fiscal year 2025 is projected to reach 115 trillion yen, and the target has still not been met. European fiscal discipline rules have become more flexible, shifting from strict rules to a "rules + flexibility" approach. In 2025, under pressure from Trump to increase defense spending, and with the Russia-Ukraine negotiations not meeting expectations, the EU activated the "National Escape Clause" (National Escape Clause, NEC), allowing member states, upon approval, to increase defense spending by up to 1.5% of GDP over four years from 2025 to 2028, while other expenditures must still comply with the rules.

The strength or weakness of post-pandemic fiscal policy determines the strength or weakness of the economic landscape. From 2019 to 2025, the average deficit rate of major global economies is positively correlated with GDP growth rate; the higher the deficit, the higher the GDP growth rate. The US has benefited the most from loose fiscal policies, and after 2020, the larger scale of fiscal stimulus in the US has resulted in a significantly higher growth rate compared to Europe. From the fourth quarter of 2019 to the fourth quarter of 2023, the GDP growth rate of the US was 4 percentage points higher than that of the EU, mainly due to stronger fiscal stimulus supporting income and consumption, which boosted the recovery speed of US GDP through private consumption.

(2) Fiscal "Championship": The "Resonance" of Loose Fiscal Policies in the US, Europe, and Japan

Next year, the US, Europe, and Japan may usher in a new round of collective fiscal expansion. The US will extend and expand tax cuts and increase defense spending through the "Beautiful America Act." On July 4, 2025, the Trump administration officially passed the "Beautiful America Act," which includes 11 major sections, expanding tax cuts, increasing defense spending, immigration enforcement spending, and cutting spending on healthcare and other welfare expenditures, as well as expenditures in new energy and other fields Tax cuts are the main content of the bill, which includes three parts: first, the extension of the original tax cuts from the TCJA, totaling $3.9 trillion; second, the addition of personal tax cuts amounting to $0.4 trillion; and third, the addition of corporate tax cuts amounting to $1.1 trillion. The Senate version increases the intensity of corporate tax cuts, making the three major deductions for corporate R&D expenses, accelerated depreciation, and interest deductions permanent; on the personal level, tax cuts continue to favor the wealthy, while reducing tax benefits for low- and middle-income groups. New time limits have been added for tax exemptions on tips and overtime income, and the child tax credit has been reduced. It is expected that from 2025 to 2034, the U.S. deficit will increase by $3.4 trillion, with the fiscal deficit remaining flat in 2025, and rising from 2026 to 2028, with the deficit rate reaching 7%.

The overall fiscal stance in Europe has shifted towards easing, expanding defense spending and infrastructure, and climate expenditures. In March 2025, the EU launched a comprehensive plan to rearm Europe, totaling approximately $800 billion, which includes two parts: first, the implementation of national exemption clauses allowing member states to increase defense spending. Member states can exclude new defense spending that accounts for 1.5% of their GDP from deficit constraints for up to 4 years, with an expected scale of $650 billion. Second, a special loan of €150 billion will be established at the EU level to support member states in procuring military equipment. Additionally, Germany's fiscal stance has become more relaxed. In March 2025, Germany relaxed its debt brake plan, exempting defense spending exceeding 1% of nominal GDP; a special fund of €500 billion will be established with a term of 12 years, of which €300 billion will be direct federal investment, €100 billion will be injected into climate and transformation funds aimed at carbon reduction and clean energy industries, and the remaining €100 billion will be allocated to states for investment.

Japan's defense spending expands, subsidies normalize, and next year's budget continues to hit new highs. After the July Senate elections, the Liberal Democratic Party coalition in Japan lost its majority status, forcing the LDP to seek support from opposition parties. The core proposition of opposition parties such as the Constitutional Democratic Party is tax cuts and lowering living costs, which may lead to a more relaxed fiscal policy in Japan in the future. In the fiscal year 2026, Japan's budget is expected to reach approximately 122 trillion yen, up from 115 trillion yen in 2025, marking a record high for the third consecutive year. First, fiscal spending accelerates national capital formation, and by 2027, Japan's defense spending may increase to 2% of GDP. Second, price subsidies are normalizing, with Japan implementing a one-time inflation subsidy in 2024, extending energy subsidies until the end of 2024, and launching a new round of fuel subsidy mechanisms in 2025.

(3) How will wider fiscal policies affect next year's economic growth rate?

In terms of the incremental deficit rate, the order of fiscal easing in the US, Europe, and Japan next year, from high to low, is: Germany, France, the United States, Japan, and the Eurozone as a whole, with Germany having a higher incremental deficit rate. In terms of fiscal stance, the US has the most relaxed fiscal position, with an expected fiscal deficit rate of 7.0% in 2026, Japan at 3.1%, and the Eurozone at 3.4%. In 2026, Germany's fiscal deficit rate is expected to expand the most by 0.5 percentage points, followed by France at 0.48 percentage points and the US at 0.4 percentage points. Japan's increase is relatively low at 0.23 percentage points, and the overall increase for the Eurozone is also low at 0.22 percentage points. There is significant differentiation within the Eurozone, with Italy and Spain likely to tighten their fiscal stance next year due to constraints from fiscal deficit reduction rules.

Next year's fiscal boost to the economy is projected to be 0.6% for the United States, 0.2% for the Eurozone, and relatively weak at 0.1% for Japan. In the United States, fiscal expansion is reflected in tax cuts, defense, and infrastructure spending. From 2025 to 2034, the Inflation Reduction Act may increase the average annual growth rate of the U.S. real GDP by 0.1 percentage points. In terms of timing, the effects will be highest from 2026 to 2028, with GDP growth rates increasing by 0.6, 0.8, and 0.7 percentage points, respectively. For the Eurozone, fiscal expansion mainly manifests as defense spending. Based on historical experience since 1960, military spending as a percentage of GDP in the U.S. and Eurozone shows a positive correlation with economic growth, but its long-term effects are generally weaker than infrastructure. In Japan, subsidies remain the primary focus, and the fiscal multiplier is relatively weak.

Next year's economic growth pattern for the U.S., Eurozone, and Japan is expected to be U.S. > Europe > Japan, with the U.S. growth still likely to lead, but Germany and France may see significant increases in real GDP growth. According to the IMF's forecast from July this year, the U.S. real GDP growth rate is expected to be 2.0% in 2026, better than this year's 1.9%; the Eurozone's growth is expected to be 1.2% in 2026, up from 1% in 2025; Japan's growth is expected to be 0.5% next year, down from 0.7% this year, primarily due to the difficulty of fiscal stimulus in offsetting the impact of tariffs. In terms of incremental growth, Germany is expected to see a significant improvement, with a projected growth of 0.9% in 2026, a notable rebound from this year's 0.1%, mainly due to the easing of Germany's debt brake, increased defense spending, and rising infrastructure expenditures.

Authors of this article: Zhao Wei, Chen Dafei, Zhao Yu, Wang Maoyu, Li Xinyue, Source: Shenwan Hongyuan Macro, Original title: "Hot Topic Thinking | Fiscal 'Championship': U.S., Europe, Japan, Who is More Proactive? (Shenwan Macro · Zhao Wei Team)" Risk Warning and Disclaimer

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