OREANDA-NEWS. A fiscally-induced growth surge alongside continued monetary stimulus could call into question "lower for longer" interest rates and the acceptance that there is little risk of inflation through the medium term, says Fitch Ratings in its latest Global Perspectives commentary. With markets so closely linked to the policy backdrop, investors should be sensitive to the changes ahead.

This week's IMF annual meetings in Washington will deliver further endorsement of a near-consensus view among advanced economy policymakers and the international policy community on the need for monetary stimulus to be supplemented by a looser fiscal stance. While this could prove supportive to economic growth in the short term, it may be accompanied by financial market disruption.

There are two reasons why financial markets could react unfavourably to successful fiscal expansion. First, there may be concerns that a return to stronger economic growth would weaken the case for continued monetary easing. Even without an immediate pickup in inflation, a growth spurt could call into question the justification for maintaining exceptionally easy money.

Secondly, a "fiscal reflation" is possible, whereby an investment-led surge in growth contributes to higher prices and wages. Investment is typically more trade-intensive than consumption spending, and employment related to trade usually commands higher wages. This also lends to the view that co-ordinated fiscal policy is most advantageous, since there can be cross-border growth support.

The final risk with the turn to fiscal stimulus is that it doesn't work. Fiscal expansions are ultimately intended to be displaced by private sector growth that, once spurred by public spending, gains its own traction. An alternative and much less appealing result is a quick return to lower growth but with higher government debt levels when public spending has run its course, an outcome in which it would not only be Japan's "three arrows" policy that other advanced economies would emulate.

Global Perspectives is a monthly commentary series by James McCormack, Fitch's Global Head of Sovereign Ratings, on key issues affecting the world economy.