The Cost of Prosperity: The Dual Narrative of Global Finance

Abstract In 2026, overseas finance and geopolitics are bound together, moving towards a pro-cyclical expansion path. Finance is both a driver of economic resilience and a source of debt risk. Current debt is overdrawing future growth capacity; how to resolve this debt may determine the boundaries of monetary independence. I. In 2025, the global fiscal stance "shifts," with expansionary fiscal policy becoming an "independent variable" beyond the cycle In 2025, the fiscal policies of the US, Europe, and Japan will synchronously shift from counter-cyclical to "cross-cyclical." First, the fiscal objective function will significantly expand, moving from traditional demand-side management to supply-side restructuring, with expenditures on national defense, industrial support, and other areas becoming essential options, making debt expansion more rigid. Second, fiscal policy will shift from passively smoothing cycles to actively guiding cycles, exhibiting stronger proactivity, with expansion no longer triggered solely by recession. At the same time, the constraints on fiscal expansion are weakening. On one hand, driven by electoral votes and geopolitical factors, the motivation for overseas parties to actively constrain debt is diminishing; on the other hand, debt risk is insufficient to prevent fiscal expansion. Developed sovereign currency countries face virtually no default risk, and debt risk has essentially transformed into liquidity risk, manifested as rising inflation expectations, increasing interest rates, currency depreciation, and falling stock markets. As a result, expanding fiscal policy has become a consensus among the US, Europe, and Japan, strengthening the policy-driven characteristics of the economy. 1) The strength of fiscal policy determines the strength of the economy; 2) The divergence between the public and private sectors is increasing, with the share of new jobs in the public sector in the US reaching 72% of total employment; 3) Debt sustainability has become a major source of market disturbance; 4) The boundaries of monetary independence are being eroded. In 2026, as policies are implemented, these impacts may intensify. II. In 2026, overseas expansionary fiscal policy "lands," with three main lines reshaping supply security, and national defense and military industry are "essential options" In terms of intensity, the most notable change is that the fiscal policies of the US, Europe, and Japan will simultaneously increase in non-recession scenarios. This marks a shift in fiscal objectives from preventing recession to focusing on security goals and industrial competition. In 2026, Japan's deficit ratio may expand by 0.8 percentage points to 3.2%, the US by 0.8 percentage points to 6.8%, Germany by 0.9 percentage points to 4.0%, and the Eurozone by 0.1 percentage points to 3.3%, with fiscal impulses in the US, Europe, and Japan higher than in typical years. In terms of direction, unlike traditional demand-oriented fiscal policy, overseas fiscal policy in 2026 will focus more on supply-side investment, significantly increasing defense spending. There are three main lines of global fiscal expansion: defense spending, AI industry subsidies, and infrastructure investment. Among these, the expansion of defense spending is the most pronounced, with Germany's defense spending increasing by 25% year-on-year, the US by 10%, and potentially rising to 50% by 2027, while Japan has already achieved its defense spending target as a percentage of GDP. In terms of sustainability, the "rigidity" of overseas fiscal expansion may be underestimated. First, supply-side expenditures such as defense and industrial investment are inherently long-term, spanning multiple years and difficult to rapidly scale back; second, influenced by political cycles, the US, Europe, and Japan may continue to increase spending, with Trump potentially expanding the deficit for the midterm elections, and the high market may continue to increase fiscal policy after early elections; third, driven by geopolitical security, re-militarization spending is no longer optional In terms of rhythm, the United States is stable after a peak, Japan's first quarter subsidy is landing, and Germany's investment is concentrated in the second half of the year. The United States will form a tax reduction pulse in the second quarter of 2026, which may transmit quickly to the economy and boost growth in the first half of the year; European policy rhythm is relatively balanced, Germany's defense spending has accelerated, and public investment may expand in the second half; Japan will start issuing household and inflation subsidies in the first quarter of 2026, which may reduce inflation. III. The "Dual Nature" of Expansionary Fiscal Policy: Growth and Risk Coexist, and the Way to Resolve Debt Risks May Determine the Boundaries of Central Bank Independence At the aggregate level, supported by fiscal policy, the economic growth rates of the U.S., Germany, and Japan still show resilience. The fiscal pull logic in the U.S., Europe, and Japan is different. The tax reduction pulse in the U.S. can quickly transmit to the economy, playing a role in accelerating growth; Japan's high debt combined with interest rate normalization may only allow fiscal policy to provide a bottom-line effect; there is significant internal policy differentiation in Europe, with incremental growth concentrated in Germany, which may moderately recover from zero growth but relies on the pace of policy implementation. The shift in policy logic suggests that the typical economic cycle patterns in the U.S. may be difficult to return to. 1) The recovery momentum comes from fiscal and industrial policies, with monetary policy constrained, raising doubts about the ability for a comprehensive recovery; 2) Changes in industrial logic mean that the safety chain has stronger industrial support, while interest rate-sensitive chains may struggle to boost growth; 3) As the economy rebounds, debt risks are also accumulating, and the market may no longer simply price growth but rather the sustainability of the growth methods. The characteristics of debt risks are changing; while the likelihood of an explicit crisis is low, the implicit costs are eroding the market. This round of overseas debt risks has four new characteristics: 1) The risk form has shifted to liquidity shocks; 2) The frequency of shocks has increased; 3) Geopolitical risks are deeply integrated with debt risks; 4) Risks have not been cleared but are continuously accumulating. These new characteristics reduce the likelihood of an explicit debt crisis, but the implicit costs are continuously eroding dollar credit and market tolerance until a shock breaks through the threshold, forcing a clearance. The way to solve fiscal issues may ultimately determine the boundaries of the Federal Reserve's independence. The three traditional methods of debt reduction in the U.S. are fiscal consolidation, financial repression, and inflationary debt reduction. Tight fiscal policy can strengthen dollar credit but is difficult to implement. The four prerequisites for financial repression and inflationary debt reduction are not yet mature. New debt reduction ideas may focus on how to increase demand for U.S. Treasury bonds and suppress interest rates. Geopolitical debt restructuring, reshaping the debt structure and buyer structure may be possible options, and Trump's probing of monetary independence will not easily cease, making the long-term trend of weakening dollar credit difficult to change. Report Body In 2026, overseas fiscal policy is bound to geopolitics, moving towards a pro-cyclical expansion path. Fiscal policy is both a driver of economic resilience and a source of debt risk. The shift in policy logic may make the familiar cyclical laws in the market difficult to return to, and the methods of debt reduction may also determine the boundaries of monetary independence. I. Fiscal Shift: Expanding the Objective Function, Weakening Constraints, and Expanding Fiscal Rigidity (1) Logical Shift: Changing Objectives, Misconceptions about Debt Risks The role of overseas fiscal policy is changing. The objectives of fiscal policy are expanding, shifting from demand-side management to supply-side restructuring and security. The objective function of monetary policy in developed economies is still anchored to inflation or employment, but under pressures from politics and geopolitical security, the objectives of fiscal policy have shifted and expanded Before 2020, the fiscal goals of developed economies focused on demand-side management, stabilizing the economy through relief and welfare spending, with weak support for industrial policy and defense. Since 2025, in addition to traditional counter-cyclical adjustments, the US, Europe, and Japan have generally increased support for key industries, supply chain security, and national defense. Fiscal policy has become a "weapon" for maintaining geopolitical and economic security, with discretionary spending represented by defense becoming a necessity, and fiscal expansion in Western countries may become more normalized. The role of fiscal policy has shifted from passively smoothing cycles to actively guiding cycles. Before the pandemic, fiscal policy often played a role in smoothing economic cycles, stabilizing the economy during recessions through tools like taxes and subsidies, and naturally contracting policy tools after economic recovery, demonstrating the ability to return to normalization. Marked by events such as the 2025 US "Inflation Reduction Act," the shift in European fiscal policy, and the expansion of fiscal policy in high markets, overseas fiscal expansion is no longer triggered by recession. Against the backdrop of the economy not stalling, policymakers have actively chosen an expansionary fiscal stance due to political, industrial competition, and geopolitical security needs, with fiscal policy no longer smoothing cycles but actively guiding them. The two major constraints on the normalization of fiscal policy are weakening, with one aspect being the reduced motivation for active fiscal tightening. The forces driving fiscal contraction can be categorized into two types: active normalization, including tax increases and spending cuts; and passive normalization, such as political deadlock and debt risks forcing fiscal adjustments. At the 2025 time point, monetary policy still possesses the ability for active normalization under the leadership of legal and technical bureaucrats; however, the motivation for overseas political parties to actively conduct debt adjustments has been continuously weakening. In the agendas of overseas political parties, the proportion of content supporting fiscal expansion has increased from 10% in the 1970s to 20% in 2020 After the 2010s, both left and right political parties in developed economies tend to expand fiscal policy, making fiscal contraction harder to generate internally. On the other hand, the constraints of debt risk are not sufficient to compress deficits. Firstly, the market often mistakenly believes that debt expansion will lead to a collapse of U.S. and Japanese debt, which may trigger debt default risks in the future. However, for developed sovereign currency countries, central banks have nearly unlimited capacity to issue their own currency, making substantial defaults unlikely. Debt crises in emerging markets often manifest as credit risks, while in developed countries with sovereign currencies, they tend to manifest as currency depreciation and inflation risks. Signals of debt expansion are transformed by the market into rising inflation expectations, increasing government bond yields, currency depreciation, and stock market declines, resulting in a liquidity shock known as the "triple kill" of stocks, bonds, and currencies, which may actually force central banks to intervene to stabilize the market. Secondly, the short-term benefits of fiscal expansion outweigh the debt risks; the political cycle in developed countries typically lasts 2-4 years, with political gains distributed in the short term and more certainty in returns. Debt risks are distributed over the long term and are probabilistic. The end result is that expanding fiscal policy has become a consensus among decision-makers in the U.S., Europe, and Japan, and debt risks may become more normalized. (2) Policy-driven: guiding cycles, creating risks, squeezing monetary boundaries The shift in fiscal policy brings three major impacts on macroeconomic operations: guiding cycles, creating fluctuations, and interfering with monetary policy. The more aggressive the fiscal policy, the stronger the economic performance, but it also leads to a greater divergence between the public and private sectors, increasing reliance on the public economy. From 2019 to 2025, changes in the deficit rates of major developed economies are positively correlated with changes in GDP growth rates; the higher the deficit, the higher the GDP growth rate. As fiscal policy is intensified before the economy loses momentum, the upward phase of the cycle is prolonged, and the probability of economic recession decreases, with the U.S. being particularly typical. Secondly, fiscal expansion leads to an increased dependence of the overall economy on government sectors, exacerbating the divergence between the private and public sectors After 2022, the proportion of employment in the broad public sector in the U.S., including government, healthcare, and education, has continued to rise, increasing from around 10% in 2021 to about 72% in 2025, while employment created by the private sector has significantly declined. Fiscal policy itself has become an important source of economic and market disturbances. The overseas macroeconomic performance in 2025 shows stronger policy-driven characteristics. Firstly, the public finance policy shocks in Europe, the U.S., and Japan spanned the entire year: in March, Europe shifted its fiscal policy; in April, the implementation of U.S. tariffs led to global market turbulence; from May to July, the "Inflation Reduction Act" triggered a triple whammy in U.S. stocks, bonds, and currencies; in October to November, the U.S. government shutdown resulted in missing economic data; and in October, the rise of high city early seedlings triggered "high city trading" in Japan. Secondly, the private economy, which lacks policy support, continues to be sluggish, while the industry chains that receive policy support continue to improve, such as the semiconductor industry chain and the divergence of the U.S. manufacturing PMI since 2022. Thirdly, expectations for fiscal expansion are rising, and the pressure of debt supply continues to become apparent, making fiscal sustainability one of the core pricing variables in the market by 2025. Fiscal policy has a greater impact on monetary policy, eroding the boundaries of monetary independence. On one hand, inflation and employment are more directly influenced by fiscal policy, with higher fiscal intensity leading to stronger inflation stickiness and greater likelihood of exceeding expectations. Influenced by Trump's tariffs, since January 2025, the U.S. inflation index for goods and durable goods has deviated from the long-term trend and rebounded, causing a delay in the timing of the Federal Reserve's interest rate cuts. Furthermore, the rhythm of fiscal policy directly affects the rhythm of monetary policy. For example, after high city early seedlings announced the fiscal stimulus plan on November 21, 2025, expectations for interest rate hikes by the Bank of Japan rose in December 2025, with loose fiscal policy putting pressure on the yen, raising inflation expectations, and leading to an earlier interest rate hike in Japan. Finally, the central bank's ability to use interest rates to adjust total demand has been weakened. In the interest rate hike environment of 2022, U.S. fiscal policy continued to support economic demand, forcing the central bank to adopt a stronger tightening stance; in the interest rate cut environment since 2024, long-term rates have not significantly declined due to term premiums, also suppressing the recovery of private demand In 2025, overseas fiscal policy is on the "eve" of shifting from neutral to expansionary, and the aforementioned fiscal impacts may further amplify. The U.S. fiscal deficit is expected to shrink in 2025, with fiscal revenue at $5.2 trillion, fiscal expenditure at $7.0 trillion, and a deficit of $1.8 trillion, a decrease of $41 billion compared to 2024, primarily due to a surge in tariff revenue to $194.9 billion, resulting in a deficit rate of 6.0% for the U.S. in 2025. Europe maintains a generally neutral fiscal stance in 2025, with the Eurozone's deficit rate at 3.1% in 2024 and projected to be 3.2% in 2025. The EU's new Stability and Growth Pact will take effect in April 2024 and be implemented in 2025, with countries like France and Italy beginning to enter fiscal tightening procedures. In Japan, after the election of Prime Minister Suga in the second half of 2025, the relatively cautious fiscal stance of the previous administration was immediately overturned, establishing a basic principle of prioritizing the economy over fiscal discipline. II. Path to Implementation: Re-industrialization, Re-militarization, Establishing a New Fiscal Paradigm (1) Fiscal Mainline: National Defense, AI, and Infrastructure Reshape Supply Security The commonality of overseas fiscal expansion in 2026 lies in supply-side investment, with three main lines of fiscal expansion: national defense security, industrial support, and infrastructure investment. In previous periods of expansive fiscal policy, the characteristics were more demand-driven, with policies primarily boosting corporate and household demand through transfer payments, social security, subsidies, and other conventional fiscal tools. For example, in 2008, social security expenditure in the Eurozone increased by 1.9 percentage points of GDP, contributing to a 46% rise in the deficit rate, making it a major driver of expansive fiscal policy. However, 2026 will be different, with a marginal strengthening of supply-side characteristics. The fiscal expansions in the U.S., Europe, and Japan will focus on three main lines: national defense security expansion, AI strategic industrial support, and infrastructure investment, exhibiting a stronger "weaponization" of fiscal policy In terms of defense, the U.S. budget for 2026 reaches $1.0119 trillion, a year-on-year increase of 10.4%; Japan's defense budget for 2026 is 9 trillion yen, reaching 2% of GDP two years ahead of schedule. Germany's defense spending is 108.2 billion euros, with a growth rate of 25.1%, the highest since the Cold War; in terms of strategic industries, Japan's investment in AI and semiconductors has shifted from supplementary funding to a regular budget, with the budget for AI and semiconductors increasing to 1.23 trillion yen in 2026, four times that of 2025. On November 24, 2025, the U.S. launched the Genesis Plan, positioned as the largest mobilization of scientific resources since the Apollo program; in infrastructure, the U.S. introduced the "Artificial Intelligence Action Plan" to build AI infrastructure in the U.S. Germany's federal infrastructure investment in 2026 is expected to reach 120.7 billion euros, 2.0 times the average from 2023 to 2025. The characteristic of U.S. fiscal policy is a strong emphasis on tax cuts, stimulating consumption and investment through tax incentives, and supporting strategic industries. The overall tax cut scale in the U.S. for 2026 is $396 billion, an increase of 47.7% compared to $268.2 billion in 2025. Among them, the individual tax cut scale is $275 billion; the corporate tax cut scale is $121 billion, with the main incremental measures for corporations including: 1) Increasing the semiconductor manufacturing investment tax credit, with the credit rate for equipment put into use after December 31, 2025, raised from 25% to 35%, and construction must start before the end of 2026. 2) Accelerated depreciation. After January 19, 2025, companies purchasing equipment, machinery, or building factories can deduct the full amount in the year of purchase, providing direct stimulus to corporate capital expenditures. 3) R&D expenditure expensing. Starting January 1, 2025, companies are allowed to fully deduct R&D expenses, which can improve the after-tax cash flow of R&D-intensive companies (semiconductors, software, AI, etc.). Google obtained $17.9 billion in cash through the legislation in 2025, accounting for 18.7% of its cash scale in 2024, while Amazon received $15.67 billion, accounting for 16% U.S. fiscal spending is concentrated on defense and infrastructure, with defense spending expected to grow by 50% by 2027, potentially accelerating militarization. In fiscal year 2026, U.S. defense spending is expected to increase by 10.4% to $1.0119 trillion, the highest growth rate since 2008; Trump plans to raise defense spending to $1.5 trillion in 2027, with a growth rate close to 50%. Border and immigration spending is set to rise from $64.8 billion in 2025 to $107 billion in 2026. The main reason is the one-time allocation of $191 billion from the American Rescue Plan, to be used over four years, adding an average of $47.5 billion per year. Additionally, trade agreements with the EU, Japan, South Korea, and others include a total investment commitment of $1.7 trillion from these countries, which could also bring investment increments in 2026. The U.S. is financing its budget through tariffs and spending cuts, which gives tariffs a stronger financing attribute; even if tariffs are deemed illegal, the effective tariff rate may only decrease by 2-3 percentage points. Tariff revenue for fiscal year 2024 is projected at $77 billion, rising to $194.9 billion in fiscal year 2025. Even if reciprocal tariffs are ruled illegal, Trump may resort to alternative measures such as Section 232 to fill the gap, with tariff revenue expected to slightly decline to $223.2 billion in 2026, and the effective tax rate may only decrease modestly by 2-3 percentage points. The scale of U.S. fiscal spending cuts may be relatively limited; based on projects already passed by Congress, education and health spending may be cut by $21 billion in 2026, while environmental and public works spending may only see a $1 billion reduction. Trump has also exaggerated the fiscal consolidation achievements of 2025, as the spending cuts in 2025 are concentrated in the education sector, totaling $177 billion, but this is merely offsetting the accounting data of student loans, and the actual deficit scale has not decreased Japan's fiscal characteristics include a significant increase in investments in strategic industries such as AI under a high debt environment, accelerated defense investments, and continued support for people's livelihoods and anti-inflation on the demand side. By 2025, Japan's government debt ratio is projected to reach 234%, far exceeding that of major economies in Europe and the United States. In 2025, government interest payments will account for 1.5% of GDP. After the new administration took office, Japan's policy focus shifted, no longer emphasizing a balanced fiscal budget for a single year, but continuing to expand under a high debt environment. In terms of industrial investment, in 2026, Japan will categorize funding for AI and semiconductors as part of the regular budget, with the budget for AI and semiconductor-related investments increasing by 1.2 trillion yen, four times that of the previous year. On the defense front, Japan's defense budget for 2026 is set at 9.0 trillion yen, with a growth rate of 3.8%, achieving the goal of 2% of GDP one year ahead of schedule. In terms of demand measures, the stimulus plan of the new administration focuses on inflation subsidies and livelihood guarantees, totaling 11.7 trillion yen, including subsidies for household electricity and gas costs, child allowances, and tax reductions, which help to lower inflation. Fiscal expansion in the Eurozone is concentrated in the defense sector, using defense to promote a European version of re-industrialization. Defense may become a new anchor point for marginal fiscal expansion in Europe, with Eurozone defense spending as a percentage of GDP expected to rise from 1.4% in 2025 to 1.7% in 2026. On one hand, the EU provides broader exemptions for defense in its regulations. In 2025, 15 EU member states have initiated defense spending exemption clauses, including Belgium, Croatia, Estonia, Finland, etc., allowing for an additional increase of 1.5 percentage points of GDP in defense spending over the next four years. On the other hand, under the rearmament plan for Europe, the EU will provide up to 150 billion euros in long-term low-interest loans for member states' defense industry investments. The loans will start disbursing in 2026, providing a one-time pre-financing of 15%, with the requirement that procured equipment must be manufactured in Europe, and non-EU components must not exceed 35%, essentially aiming to promote localization of the supply chain centered around the defense industry Germany is the main country for fiscal expansion in Europe, with a focus on infrastructure and defense. The German fiscal budget includes the federal budget and various special fund expenditures (infrastructure fund, climate neutrality special fund, defense special fund). Under this definition, the total German fiscal budget for 2026 is €633.8 billion, an 18% increase from 2025, marking the highest growth rate since 2021. There are two main increments: First is defense, with expenditures of €108.2 billion in 2026 (regular €82.7 billion + federal defense special fund €25.5 billion), accounting for 2.8% of GDP, an increase of €21.7 billion from 2025, reaching the highest growth rate since the 1990s. Germany plans to increase annual military spending to about €162 billion by 2029. Second is infrastructure investment, with public investment in Germany for 2026 projected at €126.7 billion, averaging around €60 billion per year from 2023 to 2025. According to the infrastructure fund plan, the main allocations for 2026 are: transportation accounting for 55%, hospital facilities 15%, digital infrastructure 15%, and energy facilities 5%. (2) Expansion intensity: simultaneous increase in a non-recession environment, sustainability may be underestimated In 2026, overseas fiscal pro-cyclical expansion is stronger than in typical non-recession years, with Japan and the U.S. leading fiscal expansion, while Europe shows significant internal differentiation, with the main increment in Germany. In 2026, Japan's deficit rate is expected to widen by 0.8 percentage points to 3.2%, and the U.S. deficit rate is expected to widen by 0.8 percentage points to 6.8%. The overall deficit rate in the Eurozone is expected to rise only slightly by about 0.1 percentage points to 3.3%, with the Netherlands widening by 0.8 percentage points to 2.7%, and Germany expected to widen by 0.9 percentage points to 4.0%, making it one of the economies with the highest fiscal expansion in Europe. France and Italy are entering fiscal consolidation procedures, with France's deficit rate expected to decrease by 0.6 percentage points to 4.9% in 2026, and Italy expected to decrease by 0.2 percentage points to 2.8% Compared to typical historical periods of expansive fiscal policy, a notable change in 2026 is the synchronized increase in fiscal measures by the US, Europe, and Japan without a recession. In the past, coordinated fiscal expansions abroad were often a passive response to recessions, such as the collective expansions by the US, Europe, and Japan during the recessions of 2008 and 2020. The fundamental difference in the expansive fiscal policy of 2026 is that the marginal goal of expanding fiscal measures has shifted to areas such as national defense and industrial competition, exhibiting "weaponization" characteristics, marking a shift in the logic of fiscal policy. Regionally, Japan, under the leadership of Prime Minister Kishida Fumio, has politically reversed its fiscal stance, making fiscal expansion a long-term means to accelerate Japan's "normalization"; in Europe, under geopolitical pressure, the peace dividend has been overturned, forcing a shift from fiscal discipline to defense expansion. The US fiscal policy has also strengthened its focus on supply-side investments, with the concentrated implementation of the "Inflation Reduction Act" potentially making 2026 a transformative year. Driven by geopolitical security and political cycles, the sustainability of global fiscal expansion may be underestimated by the market. On one hand, fiscal expenditures themselves have a stronger "rigidity." Defense and industrial investments often span multiple years, exhibiting greater stickiness and are difficult to withdraw quickly; secondly, under the influence of political cycles, the US, Europe, and Japan may continue to increase their fiscal measures. The midterm elections in November 2026 are crucial for Trump, with the average deficit in election years being 10.2% higher than in non-election years. Japan's final budgets have historically exceeded initial budgets, and in 2026, Kishida Fumio will no longer set a target for annual primary surplus but will establish a more flexible fiscal framework, providing greater space for cross-year expenditures. The European security plan loans may initiate a second round of expansion in 2026, making it difficult for fiscal expansions to naturally decline The legal barriers to fiscal expansion in major economies have been largely removed. Japan and Germany have passed their 2026 budgets, the Eurozone has released its 2026 fiscal stance statement, and although the United States has not passed its 2026 budget, tax cuts can be implemented. The U.S. fiscal year runs from October 1 to September 30 of the following year, and it is often difficult for the U.S. to pass its fiscal budget on time, relying instead on temporary appropriations for transition, resulting in a more conservative pace of fiscal disbursement. However, tax cuts can be implemented earlier since the legislation has been completed. Japan's fiscal year runs from April 1 to March 31 of the following year, and it often increases spending mid-year through supplementary budgets. After taking office, the Kishida administration announced a 21.3 trillion yen economic stimulus plan on November 21, 2025, which will be implemented starting January 2026. The Eurozone does not have a unified fiscal budget, and the Eurogroup and the European Commission release statements on the overall fiscal stance of member countries each year. Germany's fiscal year aligns with the calendar year, and the 2026 federal budget was approved by the Federal Council on December 19, 2025, with fiscal legal authorization in place. III. Dual-Faced Fiscal Policy: Growth on the Left, Risks on the Right, Debt Resolution Methods May Determine the Boundaries of Central Bank Independence (1) Fiscal Pulse: Overall Resilience, but Growth Logic May Have Been Restructured From an aggregate perspective, fiscal expansion has supported economic growth in the U.S., Japan, and Germany, with resilience in growth rates. The U.S. economy is expected to accelerate again, Japan's economy is stabilizing, and Germany is moving from zero growth to moderate recovery. U.S. growth is projected to rise from 1.9% in 2025 to 2.3% in 2026, exceeding long-term trends, with fiscal contributions of 0.5-0.6 percentage points, playing a role in economic acceleration. Japan's economic growth may rebound from 1.1% in 2025 to 1.3% in 2026, with high debt and interest rate normalization contributing to fiscal effects that stabilize the economy. According to estimates from the Japanese Cabinet, fiscal policy could contribute 0.4-0.5 percentage points to growth. Due to policy divergence among member countries, the Eurozone's growth rate is expected to slightly decrease from 1.4% in 2026 to 1.2%. Germany's growth rate may rise from 0.2% to 1.0-1.2% due to defense and infrastructure spending However, it is not appropriate to apply past economic cycle experiences to view the economic recovery. First, the driving force behind the cycle's recovery has changed, making a typical economic recovery difficult to replicate. A typical comprehensive cycle recovery requires participation from the private sector, beginning with monetary easing: interest rate cuts—expansion of private credit—increase in real economy demand. The driving force for economic growth in 2026 comes from fiscal policy, and the high interest rates resulting from fiscal expansion may suppress the expansion of the private sector, leading to economic improvement being more concentrated in areas directly supported by the government, raising doubts about the comprehensiveness of the recovery. On the monetary side, among G10 central banks, the number of those cutting interest rates may decrease from 9 in 2025 to 3, while the number of central banks maintaining unchanged rates may increase from 0 in 2025 to 6. The Bank of Japan continues to raise interest rates, the European Central Bank stops cutting rates, and the Federal Reserve's rate cuts in 2026 may be lower than in 2024 and 2025. Second, developed countries are experiencing a "sick" recovery, where debt risks are accumulating alongside economic recovery. During the economic recovery phase, macro systemic risks typically decrease naturally, manifested as a convergence of credit spreads, alleviation of financial pressure, and a reduction in uncertainty. For example, the recovery in the second half of 2020 after the pandemic and the recovery from the financial crisis from 2009 to 2010. However, since 2021, in an environment of high interest rates, high inflation, and high deficits, the willingness of the private sector to take on expansion risks has weakened, leading to continued deleveraging, with overall macro risks being more borne by sovereign governments, at the cost of further deterioration of government balance sheets. Economic growth in 2026 is built on the basis of debt overextension; while the growth rate rebounds, debt risks may also accumulate, manifested as frequent shocks in stocks, bonds, and currencies. In the future, the market may not simply price the economic fundamentals but rather assess whether the financing methods for recovery are sustainable Third, the logic of industrial chain recovery is no longer the same. This round of global fiscal expansion follows a safety-first logic, where defense, security, and supply-constrained industrial chains may become the core drivers of the economy, while traditional interest rate-sensitive chains such as real estate and durable goods may struggle to fully rebound. On one hand, the traditional private sector still faces obstacles in interest rate transmission, with the U.S. real estate market trapped in an interest rate lock-in effect. The U.S. real estate market primarily relies on fixed-rate loans; when market interest rates rise, existing homeowners often have lower rates than the market level, and selling their homes would require them to give up their low rates, leading to a "lock-in" of real estate transactions. According to estimates from the FHFA, for every 1 percentage point that market loan rates exceed existing loan rates, the probability of selling decreases by 18.1%. After the pandemic, U.S. real estate sales are 57% lower than they would be without the lock-in effect. The continued sluggishness in real estate weakens the housing chain's pull on manufacturing. On the other hand, geopolitical and economic policy uncertainties hinder the expansion of private manufacturing. After 2022, the financial environment and manufacturing cycle diverged; although financial conditions are loose, the manufacturing cycle remains sluggish. However, public sector-supported chains such as defense and semiconductors have emerged, with U.S. aerospace equipment production growth significantly increasing since 2025. The characteristics of fiscal dominance may lead to continued polarization in the U.S. economy, where localized prosperity may struggle to drive a comprehensive recovery in the global manufacturing cycle. Fourth, the fiscal pressure on re-inflation may be lower than market expectations, and the conditions for overheating in the U.S. economy may be difficult to meet. Loose fiscal policy can boost nominal demand and drive up inflation. On the demand side, the tax cut pulse in U.S. fiscal policy in 2026 is concentrated in the first half of the year, which may create temporary inflationary pressure. However, referencing the tax cuts implemented in January 2023, the U.S. PCE increased by 0.17 percentage points month-on-month due to consumption, but the growth rate subsequently declined In addition, due to the difficulty of a comprehensive recovery in the current economic cycle and manufacturing cycle, the sustained pressure on inflation may be lower than in traditional economic recovery cycles. Fifth, the logic driven by the supply side is strengthened, which may lead to a stronger persistence in the price increases of certain commodities. The shift in fiscal logic has substantially rewritten the pricing logic of commodities. Firstly, some commodities represented by industrial metals have begun to detach from the economic cycle, supported by independent industrial logic. In the past, commodity pricing was anchored to the global manufacturing cycle, but since the United States introduced the Inflation Reduction Act in 2022, the demand for new energy, electrification, and grid construction has risen, causing the prices of commodities represented by industrial metals to trend upwards, while the demand for traditional energy sources like crude oil has decreased, leading to persistently low prices. Secondly, the diffusion of physical currency logic. The expansion of U.S. debt and the abuse of hegemony at the expense of U.S. dollar credit have directly boosted gold as a hedging tool against sovereign credit. Since 2025, the physical currency attributes have spread outward, and physical assets such as copper, antimony, and gallium have also been endowed with stronger financial attributes. Thirdly, the rise in reserve premiums. Under tariff risks and a geopolitically uncertain environment, the risk of supply disruptions for key materials has increased, leading to a rise in the rigid demand for strategic material reserves. The areas supported by fiscal policy are concentrated in power infrastructure, military industry, and semiconductor industrial chains, while interest rate-sensitive chains are difficult to repair. Oil and gas, iron ore, and agricultural products, which are less related to strategic reserve demand, may lack medium- to long-term industrial logic, and the price increases triggered by fiscal policies may become more differentiated. Specifically regarding the fiscal stimulus methods, the roles of fiscal policies in the U.S., Europe, and Japan differ. The fiscal stimulus in the U.S. is manifested as a tax reduction pulse. The U.S. may form a round of tax reduction pulse in the second quarter of 2026, with further measures possibly taken in the second half of the year due to the midterm elections The tax reduction measures in the "Inflation Reduction Act" may be concentrated in the second quarter of 2026 (with tax refunds starting in February and peaking around April), leading to a wave of tax refunds. The total amount of tax refunds may increase by 30% to reach $412 billion, with the average refund size potentially increasing by $700 to $1,000 to $3,743. The refunds include: 1) an increase in the standard deduction; 2) deductions for tips, overtime pay, and auto loan interest; 3) an increase in the child tax credit; 4) an increase in state and local tax deductions (SALT) from $10,000 to $40,000; 5) additional deductions for the elderly. The scale of tax refunds in 2026 is expected to be close to the $96 billion cash check subsidy in 2008, which boosted consumption growth by 1.8 percentage points and GDP growth by 1.3 percentage points in the second quarter of that year, and contributed 0.8 percentage points to consumption growth and 0.6 percentage points to GDP growth in the third quarter. This round of tax cuts may boost growth in the first half of 2026. The European economy relies on spillover from Germany, which depends on the progress of investment projects. The progress may be relatively slow. Japan's high debt combined with interest rate normalization may result in a relatively weak incremental effect. Germany is the main fiscal expansion economy in Europe, with defense and infrastructure investment at its core. Its policy pace depends on debt financing and project disbursement progress. In the fourth quarter of 2025, the growth rate of Germany's debt financing showed expansion, and in December 2025, the German parliament approved a €50 billion defense order, which may lead to a rapid recovery in defense production. The growth rate of construction and equipment investment may improve in the second half of 2026. However, based on past budget experiences, Germany's actual progress often falls short of budget levels. Japan's fiscal subsidies will be disbursed in the first half of the year, which can play a role in temporarily reducing inflation. Japan will start issuing household subsidies and inflation subsidies in January 2026, which may lower Japan's overall inflation growth rate by 0.7 percentage points. High debt may lead to a weaker incremental effect in Japan. (2) Debt Risk: Risk Patterns Change, Old Debt Management Methods May No Longer Apply Since 2025, sovereign debt risks in developed countries have shown new characteristics, with default risks weakening and liquidity shocks becoming a core feature. Compared to the sovereign debt crises in developed countries before the pandemic, overseas debt risks since 2025 have several new characteristics: First, the risk pattern has changed. From 2000 to 2020, developed countries experienced three rounds of typical debt crises: the European debt crisis, and the U.S. debt crises in 2011 and 2013, all characterized by rising credit default risks. In 2011, Greece's CDS soared to 1500bps, while the U.S. reached a historical high of 82bps. Since 2025, the debt risks in the U.S., Europe, and Japan are primarily reflected in a triple whammy of stocks, bonds, and currencies, with term premiums and long-term interest rates rising disorderly as the core shock. The debt risk pattern fundamentally differs from that before the pandemic; due to lower default risks, the probability of a recession triggered by a fiscal abrupt stop may also be lower, but this also makes the inertia of debt expansion stronger. Second, the frequency of shocks has increased. On May 21, 2025, the U.S. experienced a triple whammy of stocks, bonds, and currencies due to the "Beautiful Big Law"; on August 26, political turmoil in France triggered a double whammy of stocks and bonds; on January 20, 2026, Takashi Hayashi announced early elections and promised tax cuts, leading to a triple whammy in Japan's stocks, bonds, and currencies. With weakened fiscal tightening momentum and increased debt supply, the market may rely more on marginal buyers and market makers to absorb bond market volatility. Third, geopolitical risks and sovereign debt risks are highly integrated. Higher geopolitical uncertainty forces defense expansion, and geopolitical risks, being difficult to quantify, can only be priced through higher risk premiums, with debt risks and geopolitical risks resonating in sync. Fourth, risks have not been cleared but are continuously accumulating. Currently, overseas debt risks remain at the market level and have not yet transmitted to the real economy. This is reflected in: on the banking side, the U.S. balance sheet shows resilience, with the capital adequacy ratio of U.S. banks at 15.36% as of 2025, up 91bps from 2019; On the corporate side, the U.S. credit spread is at a low level. However, each liquidity shock is consuming the market and policy's capacity to absorb, leading to a decline in the depth of U.S. Treasury trading, increasing pressure on market balance sheets, and a deterioration in buyer structure. Debt issues may continue to reappear in the form of interest rate and exchange rate shocks until a certain shock breaks the threshold, penetrating policy space and triggering a financial crisis. New characteristics overlay lead to: 1) Economic growth accompanied by debt risk, where the market may not purely price the economic fundamentals, but rather price whether the financing methods for recovery are sustainable; 2) In the short term, the probability of shocks evolving into systemic debt collapse may be low, but future debt risks may arise more frequently, forcing the government to safeguard the bond and foreign exchange markets. 3) The integration of geopolitics and debt makes traditional debt reduction methods difficult to resolve the current debt issues in developed countries. Changes in debt risk may require a transformation in debt reduction methods. Developed economies represented by the United States traditionally employ debt reduction methods including: fiscal consolidation, financial repression, and inflationary debt reduction. Firstly, fiscal consolidation may be difficult to achieve under the current geopolitical and political environment. Fiscal tightening is one of the main mechanisms leading to economic recession during sovereign debt crises, where governments are forced to tighten, cash flows are cut off, impacting the real economy, as seen in the 2010 Greek debt crisis and the 2013 U.S. government shutdown. Since 2025, debt risks have mainly manifested as rising interest rates, with default pressures insufficient to force governments to tighten fiscal policies, while industrial competition and geopolitical pressures have reduced the feasibility of fiscal tightening. Secondly, financial repression and inflationary debt reduction may lack the conditions for implementation, as both require suitable economic environments: overwhelming political objectives (war), restricted capital flows, a controllable domestic financial system, and limited alternative investment channels. Financial repression and inflationary debt reduction are two sides of the same coin, usually implemented together; the former lowers nominal interest rates, while the latter dilutes the actual value of debt, together forming negative real interest rates. If Trump forcibly lowers interest rates, it may weaken the credibility of central bank policies, inflation expectations may become unanchored, triggering disorderly interest rate increases in the market. According to BIS research, under a fiscal-dominated system, for every 1 percentage point increase in the deficit ratio, the average inflation rate over the next two years rises by about 0.5%. Under a monetary-dominated system, a 1 percentage point increase in the deficit ratio only leads to an inflation increase of about 0.1%. However, this does not mean that Trump will not challenge the independence of the Federal Reserve; historically, cases like Nixon and Johnson show that presidential pressure can help lower policy interest rate expectations and medium-to-long-term yields without triggering market backlash. But if it exceeds market expectations, it may lead to the opposite effect. The direction of debt reduction may need to focus on lowering term premiums and interest rate increases, and the direction of debt reduction may also determine the boundaries of monetary independence. The issues that need to be addressed in U.S. debt reduction are: increasing the demand for government bonds against the backdrop of continuous debt expansion; lowering nominal government bond interest rates without triggering market backlash. In the future, there may be three main lines of debt reduction: First, externally, through geopolitical actions to reduce debt, acquire resources, tax bases, and capital. This includes: 1) sharing military expenses, transferring part of the fiscal burden to allies; 2) institutionalizing and prolonging tariffs, gradually becoming a quasi-fiscal tool; 3) exchanging tariffs for investment, market access for investment, attracting capital inflows; 4) gaining control over energy, minerals, or key supply chains through geopolitical actions to seize supply-side advantages. However, geopolitical actions themselves may also raise risk premiums and damage the credibility of the dollar, thus referring to the cost-benefit principle proposed in the U.S. 2025 National Security Strategy, the U.S. may only choose to intervene in geopolitical actions when costs are low, returns are high, and they are realizable; successful geopolitical actions are a booster for confidence in the dollar and U.S. bonds. Second, internally, expanding domestic private sector demand for bonds. This includes: 1) expanding domestic institutional demand for bonds, including pensions, insurance, money market funds, etc.; further relaxing SLR to expand banks' bond purchasing capacity; 2) fiscal-central bank coordination to avoid raising term premiums when the central bank exits QE, with a high deficit environment, the probability of balance sheet reduction in the short term is low. Third, in terms of supply and institutions, lowering long-end interest rate risks without significantly reducing deficits. This includes: 1) shortening the duration of debt issuance and smoothing the issuance rhythm, which is a common proposition of Waller and Bessenbacher. 2) Setting a more stable fiscal anchor, such as a forward deficit target, Bessenbacher's 3-3-3 target, to reduce market concerns about uncontrolled debt; 3) On the political level, Trump may continue to adopt more covert ways to erode monetary independence, seeking lower interest rates without triggering market backlash The main conclusions of this article are as follows: 1. Global fiscal goals are shifting, and fiscal policy is becoming more weaponized. The role of overseas fiscal policy is changing. The objectives of fiscal policy are expanding from demand-side management to supply-side restructuring and security. The role of fiscal policy is shifting from passively smoothing cycles to actively guiding cycles. The two major constraints on the normalization of fiscal policy are weakening: on one hand, the motivation for tightening fiscal policy is diminishing. On the other hand, the constraints of debt risk are insufficient to compress deficits. 2. The logic of growth is changing, and typical economic cycle patterns may be difficult to replicate; past experiences should not be directly applied to the U.S. economy. First, the dynamics of cycle recovery have changed, making typical economic recoveries hard to reproduce; second, developed countries are experiencing "sick" recoveries, where economic rebounds are accompanied by accumulating debt risks; third, the logic of industrial chain recovery is shifting, with security demands potentially exceeding efficiency demands; fourth, fiscal pressure on re-inflation may be lower than market expectations. 3. The market may not simply price economic fundamentals but may place more emphasis on whether the financing methods for recovery are sustainable. In typical economic recovery phases, macro systemic risks tend to naturally decline, but the economic growth in 2026 is built on debt overextension, and the logic that a strong U.S. economy equals a strong dollar may continue to be challenged. In the short term, the probability of debt risks evolving into a systemic crisis may be low, but liquidity shocks may occur more frequently, pressuring the government to protect the bond and foreign exchange markets. 4. The fundamental reason for the erosion of monetary independence is the deterioration of fiscal issues, and the direction of debt resolution may determine the boundaries of monetary independence; the long-term trend of weakening U.S. dollar credit may be difficult to change. Fiscal consolidation may be hard to achieve under the current geopolitical and political environment. U.S. financial repression and inflationary debt resolution may lack the conditions for implementation, as both require suitable economic environments: overwhelming political objectives (war), restricted capital flows, a controllable domestic financial system, and limited alternative investment channels. To avoid triggering market backlash, Trump's challenge to monetary independence may be more covert. Risk warning and disclaimer Markets are risky, and investments should be made cautiously. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Investment based on this is at one's own risk.