Yves here. This article gives a very helpful, high level summary of what European, and particularly Italian, economists have learned since the 2008 crisis yet have not put sufficiently into practice. While they have found out that austerity, particularly in recessionary/depressionary times, makes debt to GDP ratios worse, they have only partly recanted their old approach. Author Antonella Stirati explains how the various European recovery programs fall short from Italy’s vantage. Since Italy is the sick man of Europe and an Italian banking crisis has the potential to kick off a Creditanstalt global crisis, what happens to Italy matters.
By Antonella Stirati, Academic Council, Professor of Economics, Roma Tre University. Originally published at the Institute for New Economic Thinking website
The Eurozone and the European Union are now debating several schemes for recovery. These proposals differ profoundly in the weight they place on various institutional vehicles for recovery. Some suggest that Italy and other countries should rely on the European Stability Mechanism. Others emphasize a proposed new Recovery Fund. Evaluating these options is difficult, because of the complexity of the considerations involved.
Normally countries needing assistance shun the European Stability Mechanism, because of the harsh conditions attached to its use. European Union authorities have responded by fashioning a set of rules for a “pandemic” ESM that would be less heavy handed than earlier Eurozone interventions, as, for example, in the case of Greece. But despite the absence of ex-ante conditionality (save in regard to the allocation of funds) even this new form of ESM-lite harbors significant dangers since its use still involves ex-post surveillance by Eurozone authorities of the macroeconomic outlook and budgetary policy of debtor countries. It is also fully embedded in the regulatory framework of the Euro Treaties and thus in those fiscal rules that have already demonstrated their dysfunctionality, especially in times of crisis.
The Recovery Fund proposal advanced by the European Commission has only a very small component, in the case of Italy, of “grants” in the sense of fiscal transfers. But the Fund would have the important advantage, within the current institutional framework, of allowing the country to carry out public investments that promise to help growth in the economy in the coming years, while repaying the funds over a long period of time.
In this commentary, I begin by outlining the macroeconomic framework necessary to understand what is at stake and the likely effects of economic policies; I will then briefly describe what is currently being done in Europe and elsewhere; then turn to the difficulties of the Italian situation, a possible (narrow) path of growth and stabilization, and finally discuss European proposed measures against this background.
1. Changes in “mainstream” macroeconomics, institutional analyses and policies since 2008
The standard version of macroeconomic models taught in textbooks before 2008 predicted that restrictive fiscal policies would have negative effects in the short term, but neutral or positive in the medium to long run as they would favour growth in private investment and/or private consumption. In the 2000s the so-called expansionary austerity thesis spread (mainly promoted by Italian economists with an international profile) predicting that austerity policies could immediately and exclusively have positive effects on GDP growth. This thesis was immediately criticized, in particular by researchers at the IMF, but it was nevertheless widely used in Europe and Italy to support the austerity policies implemented after the crisis.
After 2008, many studies have reviewed the effects of recessions and austerity policies. These studies have generally led to radically different conclusions from previous ones:
1) Restrictive fiscal policies always have negative effects on GDP.
2) The negative effects of restrictive fiscal policies (as well as those of recessions) do not have transitory (short-term) but persistent effects. That is growth resumes, but GDP does not return to its previous trajectory, there is lasting damage.
3) The effects of fiscal policies are stronger in recession or stagnation: i.e., restrictive fiscal policies in an economy already in crisis cause greater damage than if they were carried out in a “healthy” economy.
4) Given the above points, it may happen (and has generally happened after 2008, particularly in European economies subject to austerity) that restrictive fiscal policies cause an increase in the debt-to-GDP ratio.
5) Expansionary fiscal policies, if they have a sufficiently high impact on GDP, may reduce the debt ratio. That is, the debt ratio can be reduced by deficit-spending policies, provided the spending is such as to ensure a significant impact on GDP (a high fiscal multiplier).
These views have slowly percolated even into – to some extent – the European institutions and we find them in the supporting document to the Commission proposal on the so-called Recovery Fund:
The overall package is ‘self-financing’. A large share of the financing supports public investment; this has a multiplier larger than one, meaning one additional euro in public investment leads to more than one euro additional of GDP […] The assumed favourable effects from additional provision of finance to the private sector increase government revenues via automatic stabilisers. […] By 2030, the average debt-to-GDP ratio in the EU is estimated to be almost 3 percentage points lower than in the baseline scenario. (Commission Staff Working Document – Identifying Europe’s recovery needs,27/5/2020; doc 520020SC0098, p. 31).
The same document forecasts for high debt countries a reduction in debt–to-GDP of 5 points by 2024, and 8.5 over a longer period compared to what would be without the spending policies allowed by Next Generation EU program the Commission proposes.
In the light of this now widely shared economic analyses, we must therefore stop thinking that more deficits always mean more debt-to-GDP, and that in order to reduce the latter, budget surpluses must be the rule. The macroeconomic effects are more complex, since GDP is not independent of public budget policies.
What has just been said about the evolution of macroeconomic analyses is mirrored by what is being done in the various countries in response to the crisis. Everywhere we see extremely expansionary fiscal policies, much more than in 2008 and after. According to data provided by the International Monetary Fund (Policy responses to Covid, updated 24/6/2020), in the US there were more than 3,000 billion dollars (about 15% GDP) of direct expenditure and tax cuts; in Japan about 21% of GDP; in Germany, €327 billion between regional and federal levels of government, about 14% of GDP. The fiscal stimulus is much more moderate in Italy, where measures have been approved for 5% of GDP, and in Spain (3.2% of GDP).
It should therefore be noted that the pattern of national fiscal stimuli at the moment in the Eurozone is such as to exacerbate the processes of divergence already underway in the Eurozone.
Monetary policy in all the large countries outside the euro area has accompanied fiscal expansion with a variety of exceptional measures, which have everywhere also involved an unlimited purchase of government bonds together with an explicit commitment to maintain low and stable interest rates on public bonds in the future.
2. The European context and the Italian situation
As far as fiscal policy is concerned, the fiscal rules of the European treaties have been temporarily suspended in Europe. In addition to the ‘pandemic’ ESM and the proposed Next Generation EU (Recovery Fund), to which I will return, the SURE fund of 100 billion has been set up to support the unemployed along with 25 billion guarantees from the European Investment Bank to support credit for businesses – rather little in terms of macroeconomic impact for the EU27.
So far, therefore, the additional public spending needed to face the health emergency and to compensate the incomes lost because of the latter has been provided by national governments and generally funded by issuing public bonds.
For monetary policy, the ECB has launched government bond purchase programmes (extended until June 2021) with temporary flexibility regarding the rules that impose proportionality criteria between countries (the so-called “capital keys”). In fact, the ECB normally has to buy bonds strictly in a proportion reflecting Eurozone countries weight in the European GDP and hence in the ECB capital endowment. Relaxation of this rule, along with the large amount of purchases, have contained interest rate spreads across Eurozone countries.
Note however the uncertainty due to the suspension but not revision of monetary and fiscal rules. The German Constitutional Court ruling, which questioned the legitimacy of the quantitative easing policies undertaken by the ECB before the Covid19 crisis has added to the uncertainty.
In this uncertain context, Italy has to reckon with its high debt-to-GDP ratio, which comes from a long time ago, and which thirty years of primary surpluses have failed to bring down. Italy entered the 1990s with an already high public debt (about 120% of GDP). This was due not to high public spending in comparison with other European countries, but to insufficient tax revenues and high interest rates during the 1980s associated to monetary and exchange rate policies that generated a snow-ball effect and a doubling of the debt-to-GDP ratio. Since 1992 Italy has always had primary surpluses (the only country in the eurozone). This means that fiscal revenues have always exceeded public spending in services, investment and transfers (such as pensions and unemployment benefits), except interest payments. Even disregarding the consequences for the quality of welfare and public infrastructure, such surpluses slowed down GDP and productivity growth because of their negative impact on aggregate demand.
Despite this, low interest rates allowed a reduction of the debt-to-GDP ratio to a 100% in 2008.
However, the fall in GDP in 2008 brought the debt-to-GDP ratio back to 120%. After the crisis, austerity policies undertaken during the ‘interest rate spread crisis’ led to a further fall in GDP in 2012 and 2013 (-4.5% in two years) and a persistent increase in the debt-to-GDP ratio to 135%. In 2019, Italy had not yet recovered the levels of GDP and employment (measured in in hours worked) of 2007.
The current situation is for an expected fall in GDP of around 10% in 2020 and then a recovery by about half of that percentage in 2021. Together with current budget deficits, this would bring Italy’s debt-to-GDP ratio roughly at 160% this year and around 155% next year. Although Italy has some strengths such as high private wealth and a net external debt close to zero, under current European monetary and fiscal rules, the high debt to GDP ratio is a problem. Unfortunately, these rules are difficult to change, although it is now widely recognised that they are dysfunctional and pro-cyclical, i.e. they tend to amplify recessions and as recently stated by Lagarde, need to be changed.
The only possible path for Italy in the present context is one that maintains, for long periods of time, the average nominal interest rate on the entire stock of public debt lower than the nominal GDP growth rate:
r < g
Very simply, if the primary budget is balanced, r is the rate of growth of debt, while g stands for GDP growth.
The ideal solution for Italy (as well as for other European countries) to get out of the high debt would be the transformation into perpetuities, or very long maturity bonds, of the public debt already held by the Bank of Italy (purchased on ECB mandate).
The purchase of perpetuities by Central Banks is currently proposed by many parties, even of high technical and institutional profile, but for now ECB President Lagarde has branded it as a purely intellectual exercise and, unfortunately, the proposal does not seem to be on the agenda. In its absence, it is necessary at least to guarantee the rollover of the debt stock and the closure (or sharp tightening) of the spreads now and in the future through the intervention of the ECB in the secondary markets. That this is necessary is also pointed in a recent article by Fabio Panetta, member of the ECB board,and is basically what central banks outside the Eurozone are doing everywhere. However, the outlook for the eurozone is uncertain on this point too.
Thus, the average interest rate on the debt stock is basically in the hands of the ECB and in its ability to ‘reassure the markets’. For Italy, the intervention of the Central Bank is essential, since the major problem is not how to finance current deficits, but to refinance the stock of debt that each year comes to maturity (an order of magnitude of hundreds of billions a year) at a low interest rate. Of course, measures aimed at bringing the public debt back into Italian hands, and at channelling Italians’ wealth into public investments, as currently attempted by Italian government, are also useful. Their purpose is to help take public debt away from highly speculative financial institutions and markets and keep the interests paid inside the national income-expenditure circuit. But this should take place at low interest rates – from this point of view, it could be interesting to anchor the returns to nominal GDP growth, with a gap.
The other crucial variable is the growth rate of the economy: the advocated ‘reforms’ often demanded by European institutions can be useful (enhancing public administration efficiency, funding research) or harmful (such as labour market deregulation) but even when useful they have no appreciable effect on growth. The latter can only be stimulated by export support policies and public budget policies with a high impact on GDP (i.e., implying high fiscal multipliers – see the Commission’s ‘technical’ document quoted above). Private investment is, of course, very important, but we know from economic analysis that, at an aggregate level, the single most important factor in stimulating it is demand growth.
Despite the variability of estimates of the absolute values of multipliers, there is wide convergence in the economic literature on the hierarchy of multiplier values.
– The fiscal multipliers of tax reductions (in particular on medium and high incomes) and transfers to businesses are much lower than those of other public spending items.
– The highest multipliers are those of public investment, followed by public consumption expenditure (health, education, etc. – that is, the hiring of staff to provide those services).
Italy should therefore focus on public expenditure with a high multiplier: investments and growth of (qualified) employment in the public sector, which is currently extremely undersized compared to what happens in other European countries.
An increase in interest rates, and/or an attempt to reduce the debt-to-GDP ratio through policies geared to producing primary surpluses in the near future would have steeply increase the debt-to-GDP ratio. The result would be a vicious circle that would lead the country to have to choose between Italexit on the one hand or default with a banking crisis plus intervention of the troika on the other.
3. An assessment of the main European measures: ‘pandemic’ ESM and Next Generation EU (‘Recovery fund’) proposal from an Italian perspective.
In the Italian and European public debate both measures are often presented as generous gifts to Italy from European institutions and European partners, with Italy often presented as a major beneficiary of ‘fiscal tranfers’ from other European countries. But this is not true.
3.1 The ‘pandemic’ ESM
It is a loan that in the case of Italy would at most amount to 37 billion Euros for direct and indirect health care costs, with a 10-year maturity and very low interest rate. The amount would, however, add to Italy’s public debt. The only ex-ante conditionality concerns the broad classes of expenditure.
Advantages in terms of savings on interest payment are small if compared with the alternative of financing such expenditure by issuing public debt bonds. At most and under very extreme assumptions the savings might amount to 700 million Euros per year for 10 years. In fact, though, the savings are much more likely to be around 400-500 million Euros per year – less than 1% the interest payed each year by the Italian government, which amounted to around 65 billion Euros in 2019.
An indirect and very unlikely advantage can be attributed to the fact that recourse to the ESM is a necessary, but not sufficient condition for the ECB to embark on an ‘outright monetary transtactions’ (OMT) programme of unlimited purchase of the country’s securities by the ECB. But this seems extremely unlikely without further conditions and would be undertaken only in dire emergency.
Despite declarations that no conditionality is attached to the programme, some pitfalls arise from the fine print in treaties in which the ESM is embedded, explicitly referred to in the official documents that describe the ‘pandemic’ programme. Under these rules, ESM debtor countries are subject to post-programme surveillance. As Carlo Cottarelli and Enzo Moavero explained very well in a recent article on the Italian newspaper “La Repubblica”:
The effects of the inescapable ‘enhanced surveillance’ are nevertheless significant for the State (see Article 3): a closer investigation of its finances, with the obligation to provide at EU level the same information as under the excessive deficit procedure; the ‘regular review missions’ of the Commission, the ECB, “where appropriate, with the IMF” (the same actors, albeit with a different role, as the Troika); then, the EU Council may – a nodal point – recommend to the State “corrective measures” or a “macroeconomic adjustment programme”, a weighty “recommendation’, especially when combined with the fear of negative market reaction. (Carlo Cottarelli and Enzo Moavero, “La Repubblica”, 28 April 2020).
Thus, negative evaluations of the Italian situation that typically cause turmoil in financial markets could have rather high costs.
In addition, the document accompanying the ‘pandemic’ loan that provide the required favourable assessment of EU countries debt sustainability, contain an expected time-profile of public budget balances. This foresees for Italy an overall budget deficit of 2% in 2026, and thus a sizeable primary surplus, higher than those required of Italy in past years, since the deficit is the same as expected for 2019, though interest payments in proportion to GDP will be higher in the next years given the increase in the debt-to-GDP ratio. In other words, a full return to pre-crisis fiscal rules and policies, to which the country is expected to adhere. As explained above, these would indeed have ‘perverse’ effects on the debt-to-GDP ratio, owing to the negative effects on the denominator.
3.2 The Next Generation EU (‘Recovery fund’) proposal
According to the Commission’s proposal, this would be a ‘package’ of €750 billion over 4 years (for all 27 EU countries) that can be disbursed as loans or grants involving a ‘fiscal transfer’ component.
Before we consider the distribution of the fund as it emerges from the Commission documents, let us see how it would be financed.
For all E750 billion, the Commission will turn to financial markets and issue bonds with maturities between 2028 and 2058 at low interest rates. The programme will therefore not (initially) burden individual countries’ budgets and the calculation of their public debt (Commission staff working document, p. 2).
Interest rates on these securities would be paid by the Commission from ‘own resources’ (VAT, ‘green’ taxation; taxes on multinationals). Concerning these resources, it is reasonable to assume that the contribution from each country to the Commission’s revenues will be proportional to its share of European GDP (12.8% for Italy in 2019 – here, as in the European documents, reference will be made to last year’s figures).
Repayment of securities at maturity:
• Own resources’ from the Commission’s taxation;
• Repayment to be provided by individual countries, in different proportions depending on the instrument used (grants or loans). Individual countries will most likely gather the resources necessary to repay the loans and grants by issuing national public debt bonds. However, the deferment and long maturity of the securities issued by the Commission (i.e. 2028-2058) is very helpful in easing the reimbursement.
• Loans must be returned in full by the receiving country and may be requested by each country up to a maximum of 4.7% of its GDP
• ‘Grants’ are distributed among countries (i.e. their maximum availability is determined) according to a set of indicators (in particular, per capita income levels and unemployment); they are reimbursed according to the share of EU GDP represented by the country. For Italy, simulations of the Commission proposal in the technical accompanying document envisage a maximum disbursement of 20.4 % of the funds available as grants and a refund rate of 12,8 %.
Of the EUR 750 billion planned, the largest amount concerns the measures provided for in the programme called Recovery and Resilience Facility: 560 billion, divided between 310 of ‘grants’ and 250 of loans both to be used for public investment (mainly ‘green’ and digitisation) and reforms.
The remaining 190 out of the 750 foreseen by the ‘Next generation EU’, spread over a variety of already existing European programmes; of these, 140 would also be distributed as ‘grants’ according to the accompanying technical report (the main items being regional funds for cohesion policies for 50 billions; support for business and private investment for 36 billion; natural resources and environment, 30 billions).
The maximum amount Italy could obtain of the 560 billion according to the parameters indicated above is 63 billion out of the 310 available for ‘grants’, divided over 4 years; plus an overall maximum of loans equal to 4.7% of GDP, i.e. about 83 billion euros overall, spread over 4 years.
Of the remaining 140 billion, by the same criteria Italy would receive a further 28 billion in grants. Altogether, the maximum additional expenditure according to the proposal would be for Italy about 174 billion – 43 billion per year if spread over 4 years, equal to 2,3 % of 2019 GDP. If additional, the expenditure is of a size that can have a favourable macroeconomic impact.
Fiscal Transfers to Italy: very small
The net contribution received by Italy (the fiscal transfer) on the basis of the parameters suggested in the proposal is very small; the countries receiving a substantial net contribution are the East European countries and to a lesser extent Spain, much less Italy. The net contribution to Italy would be at most around 8.5 billion per year for 4 years. This compares with Italy’s annual netcontribution to the European budget, which in the past has been for several years between 4 and 5 billion Euros annually (5 billion in 2018), and will probably increase, owing to the intended expansion of the budget in the coming years.
This should make it clear that whatever benefits that might accrue to Italy are not linked to a ‘fiscal transfer’ implicit in the Next Generation EU, and that needs emphasizing during the negotiation process.
For the plan to have a macroeconomic effect, it is imperative, as the accompanying report points out, that the planned expenditure is additional and not a substitute for other expenditures, and that it be concentrated on high-impact expenditure items.
Obviously, the content of conditionality is insidious – will it only concern the destination? what will the proposed reforms be? – and so is the surveillance on implementation, with the possibility that subsequent tranches of funding could be denied. This entails risks linked on the one hand to Italian inefficiencies in spending, but on the other hand also to the influence of political motives on evaluations (which may become more or less severe according to the political orientations and alliances of the parties in government), or to the possible ‘vested interests’ of net contributors in limiting the disbursement of funds.
Since the ‘fiscal transfer’ component is very limited in the case of Italy, in my view the government could and should insist, during negotiations, on a number of points, such that:
• conditions’ and targets are established together with the government and that counterproductive ‘reforms’ with undesirable social consequences (e.g. further flexibilization of the labour market or wages) can be avoided.
• periodical ‘reviews’ on public investments and agreed reforms by European institutions are conceived as technical support and not as leading to ‘judgments’ possibly followed by ‘sanctions’.
• the rules should not be designed in such a way that a country’s failure to obtain the maximum amount of the funds available as ‘grants’ would turn it from net beneficiary into net contributor.
• maturity of the securities issued by the Commission, which is the real element allowing a macroeconomic impact of the measures, is further extended;
• the indicators used for allocating the funds include the economic damage suffered as a result of the pandemic (e.g., a fall in GDP and fall in employment, including hours of lay-off, in the first part of 2020 – if such data can be rapidly made available).
To sum up, the advantages of the Next Generation EU proposed by the Commission do not lie – at least in the case of Italy – so much in the presence of ‘fiscal transfers’. (i.e. non-refundable resources) as much as in the temporary removal of spending constraints, with the expenditure not affecting the debt accounting (in fact, a kind of temporary ‘golden rule’ on some public expenditure items), along with the long term maturity and low interest rates on the funds obtained. Indeed, the introduction of a ‘golden rule’ – meaning that public investment is taken out of the public budget accounting and that fiscal revenues would have to be balanced with current expenditure only – has been often advocated as a needed reform of European fiscal rules, even in a recent report by the European fiscal board.
Thus, the contribution of the Commission is essentially in making available the instrument of the debt issuance. The advantages lie to a large extent in the possibility of a temporary overcoming of the European fiscal rules, which should in any case be changed because they are highly dysfunctional. This must be clear to Italian and European public opinion and made effective in the negotiations.
At any rate, whatever the size of the ‘Next Generation EU’, the ECB’s intervention will remain crucial, since without it, the rollover of the debt stock at sustainable interest rates cannot be guaranteed.
 For a review of the literature referred to and further evidence see D. Girardi, W. Paternesi Meloni; A. Stirati, Reverse Hysteresis? Persistent effects of autonomous demand expansions, Cambridge Journal of Economics, February 2020
 Despite 200% in the GDP-public debt ratio, Japan enjoys high private savings and wealthy households, and has no net foreign debt – in these respects it is similar to Italy, but unlike the latter also enjoys very low interest rates on public debt.
 In the Italian context, interest payments on public bonds tend to accrue mostly to large firms, banks, wealthy household, foreign financial institutions. Accordingly, they do not contribute to the formation of domestic aggregate demand.
 Paternesi Meloni W. e Stirati A., (2018) Macroeconomics and the Italian Vote, INET Blog, August 2018, https://www.ineteconomics.org/perspectives/blog/macroeconomics-and-the-italian-vote;
Storm, S. (2019). Lost in deflation: Why Italy’s woes are a warning to the whole Eurozone, INET WP No. 94; https://www.ineteconomics.org/perspectives/blog/how-to-ruin-a-country-in-three-decades; Heimberger P. and N. Krowall (2020)Seven ‘surprising’ facts about the Italian economy, Social Europe, 25th June 2020; https://www.socialeurope.eu/se…
 European Fiscal Board, Assessment of EU fiscal rules with a focus on the six and two-pack legislation, August 2019
 “..what is needed now is for countries to use their collective strength to ensure that the European response is commensurate with the size of the shock and that all countries can benefit from low funding costs and zero rollover risk… the goal of fiscal policy must be to push the financing costs of this crisis far — very far — into the future. Debt that is issued at very long maturities becomes more sustainable over time as growth rates outstrip interest rates” F. Panetta, Joint response to coronavirus crisis will benefit all EU countries, 21 April 2020: https://www.politico.eu/articl…
 See Gechert, S. (2015). What fiscal policy is most effective? A meta-regression analysis. Oxford Economic Papers, 67(3), 553–580; Deleidi, M., Iafrate, F., & Levrero, E. S. (2020a). Public investment fiscal multipliers: An empirical assessment for European countries. Structural Change and Economic Dynamics, 52, 354-365, among others.
 There is some uncertainty about exactly what indirect expenditure means. On the other hand, 37 billion is too much to spend all of it on health care, especially so since the loan, being a once-for-all provision, could not be used for hiring additional staff, whose costs would be a permanent addition to public expenditure.
 In the Term sheet: ESM Pandemic Crisis Support, May 2020, for example we find among other things that: “The ESM will implement its Early Warning System to ensure timely repayment of the Pandemic Crisis Support.”
 Both authors have a high institutional profile and are strongly in favour of European integration. In earlier governments Enzo Moavero has been the Ministry of Foreign affairs and before that the Ministry of European affairs.
 ESM, pandemic crisis support, Annex II – Assessment of public debt sustainability and COVID-related financing needs of euro area Member States, 07 May 2020, table 1, p. 3.
 The numbers and parameters used are taken from three documents: Communication from the Commission to the European Parliament, the European Council, the Council, the European economic and social committee and the Committee of the regions, Brussels, 27.5.2020 COM(2020) 442 final; Commission Staff working document – Identifying Europe’s recovery needs. Brussels, 27.5.2020, SWD(2020) 98,final; Proposal for a Regulation of the European Parliament and of the Council establishing a Recovery and Resilience Facility, Brussels, 28.5.2020 COM(2020) 408 final 2020/0104 (COD). The figures I report are partly different from those presented in Table A.1 attached to the second of the above mentioned documents, as the data in the table are in partial contradiction with the contents of the same and other documents. In particular, in table A.1 the ‘loans’ are not considered as to be returned at 100%, contrary to what stated elsewhere and suggested by the distinction between loans and grants. As a result, in our calculations the fiscal transfers to Italy are lower than reported in Table A.1. In any case, as this is a proposal still under negotiation, the figures must be regarded as simply illustrative of the general outlook of the proposal.
 Calculated as 20,4% of the total amount of grants (450) minus 12,8% contribution to the same: 91 – 57.6 = 33.4 to be distributed over 4 years
 European Fiscal Board, Assessment of EU fiscal rules with a focus on the six and two-pack legislation, August 2019
I think a crucial flaw in most countries fiscal and monetary policies is that the main decisions are usually made by people in the economically strongest parts of the country. So the decision maker looks out of his office window in NY or London or Tokyo or Berlin and thinks to himself ‘looks fine to me, everyone busy as usual, cafes full, lunch costs way too much, my wife says we have to wait 2 weeks for a plumber….’. So I’ve been saying here for some time that there will only be movement in the Eurozone when key individuals in The Hague, Vienna and so on are feeling the same pain as someone in Andalusia or Emilia-Romagna. I think that intellectually its now recognised that a new approach is desperately needed in the Eurozone, but there simply isn’t the urgency yet to implement it. From what I can see, there are still infuriatingly stupid arguments being made, particularly from the smaller Northern European countries such a the Netherlands and Austria, which seem to be suffering from chronic and near terminal smugness.
One other tangentially related point about austerity. It’s often forgotten in the debate that smaller open economies operate very differently under austerity than the larger ones. In these countries austerity sometimes does work – if they have the good fortune to be able to ‘import’ growth. This occurred twice in Ireland, once in the early 1990’s, and more recently in the mid 2010’s. Strong growth took place despite stinging domestic austerity, but this was mostly due to the country being able to export its way out of trouble. The austerity did have the positive impact of significantly lowering borrowing costs. However, the damage done by austerity greatly hamstrung the countries ability to reconstruct its economy during the better time, due to a need for catch-up investment.
There is also the double inverse of that effect: government stimulus is less effective in small countries, because it leaks away as imports. What is effective for small countries, is competitive devaluation . But that is rather zero-sum, your extra demand is some elses deeper recession. And small countries are similarly very sensitive to other people’s devaluations.
You can see this “small country” way of thinking reflected in the Eurozone, I think. It’s set up to prevent mutual devaluation wars, because countries have deep and nasty institutional memories of those. It is not set up to deliver American-style demand stimulus*, because countries do not have good memories of that.
* European countries do usually have automatic Keynesian stimulus through the welfare system, but that have to be sold as such.
You can also expand this demand stimulus leakage a lot further than just fiscal effects.
As a thought experiment, consider how an EU Member State could ever implement a Jobs Guarantee policy. It couldn’t. It would have to potentially soak up all unemployed EU citizens across all the other Member Stares because, under Freedom of Movement rights, anyone could move to the Member State operating such a policy and could not be denied a job under the Job Guarantee. Clearly, this would destabilise not only the Member State trying to solve an unemployment problem through a Job Guarantee but also other Member States which would suffer depopulations especially of their youth unemployed.
Of course, the Member State wishing to implement the Jobs Guarantee could seek to make this a policy across the EU. But what about the Member States which weren’t convinced? They would naturally refuse.
So what we are talking about is not really demand leakage or labour leakage or fiscal policy revenue leakage causing the problem. It is sovereignty leakage.
This is not how it works. Western european countries have far better social nets to catch their citizen in case of job loss or such than eastern european ones. They can explicitly deny this social welfare to eastern european immigrants and this has already been tested in the courts. So they could design the job guarantee in the same way.
The problem goes deeper than that. The theory of a job guarantee (apart from acting as a standard unemployment benefit program) is that it puts pressure on the private sector – they have to match or exceed the terms of the guarantee, or they cannot find workers.
But that logic doesn’t work very well for small, open economies. Too much of the economy is either exporting, or competing with imports. Those sectors won’t easily match the terms of a job guarantee, they just disappear.
Note that this does not crucially depend on migration to the country. It’s enough that a significant chunk of tradeable production can move out of the country.
A country like the US can (if they want to) tackle such issues with various trade barriers. But small countries have not much clout there – they get hit back with painful counter-measures.
It doesn’t make a job guarantee impossible, but it does severely restrict how far you can push it. Small countries have limited practical sovereignity, regardless whether they are in the EU or not.
I do agree, sovereignty works completely differently if you’re, say, the US or China than it does if you’re, for example, France, Germany, Italy or the UK. And different again if you’re Denmark.
But then again, if you take Denmark and Switzerland (fairly comparable in most aspects, overall), they have entirely different interpretations of how far you can push sovereignty. Few would say that Switzerland has given up on sovereignty — far from it. And in terms of tradable goods and services, Switzerland also seems to see sovereignty as a tool to achieve competitive advantage.
And sometimes the EU does seem to be channelling its inner Norma Desmond (“I’m still big; it’s international capital that got smaller!”) which is true up to a point, but even the EU has to throw in the towel and accept reality https://www.bloombergquint.com/business/european-regulator-budges-on-equity-trading-rule-ahead-of-brexit rather than sleepwalking along the giddy heights of a lost liquidity.
I’m not really seeking here to espouse one particular approach as being inevitably better than another. More to suggest that if you pool sovereignty, in the way the EU does, you have to be careful on what basis you’re doing that. Are you doing that to enable greater permissibility — i.e. you have an ethos which says that once one nation decides to do something, everyone else quickly adopts the idea so beneficial changes can quickly permeate (but risking deleterious ideas get propagated quickly)? Or are you doing it to enforce restrictivity — i.e. you stop nations from taking actions which might turn out to be harmful (but risking beneficial ideas from being quickly implemented)?
Of course what’s “beneficial” and “deleterious” is in the eye of the beholder. Here, in terms of discussions on fiscal stimulus, most I would say who read Naked Capitalism are firmly in the “it’s a benefit” camp. So in this instance, the EU is getting in the way of taking prompt right action.
But what do you do about that, then? Antonella Stirati (and others) writing well-argued and coherent articles seems to be about the limit. Wouldn’t it be nice if people could just, as Europeans, vote on it? Then, different parties could offer different policy choices. And the prevailing majority views of Europeans would win the day.
Why isn’t that happening, you have to ask.
an aside: the US federal system was built on the legal structure that what is not explicitly granted to the federal govt is reserved for the states. It’s a balance in constant tension and power has mostly increased in the fed. govt. but it could go the other way. SC Justice Louis Brandeis referred to states as the “laboratories of democracy”.
What’s surprising about the EU’s federal design is, if I understand it correctly, that it granted most of the power to its federal level structure at its beginning and very little power to its member states for themselves. That’s a problem, I think.
I should add that when the US Constitution was written, the fed govt had very little power in the design of the Constitution. The state govts were stronger than the fed govt. The shifts in power between state govt/ fed govt. evolve to meet new conditions. It doesn’t sound like the EU has anything like that mechanism.
Credit where it is due. That’s an excellent comment PK and I am much obliged to you for it.
How can you kill growth in your economy?
This is what the West did before 2008.
Japan led the way and everyone followed.
At 25.30 mins you can see the super imposed private debt-to-GDP ratios.
What Japan does in the 1980s; the US, the UK and Euro-zone do leading up to 2008 and China has done more recently.
The PBoC saw the Minsky Moment coming unlike the BoJ, ECB, BoE and the FED.
Japan had done what the US did in the 1920s.
When you use neoclassical economics, policymakers run the economy on debt until they get a financial crisis.
Policymakers don’t realise it’s the money creation of bank loans that is making the economy boom as they head towards a financial crisis.
How did Japan avoid a Great Depression?
They saved the banks
How did Japan kill growth for the next thirty years?
They left the debt in place and the repayments on that debt killed growth.
Richard Koo had studied what had happened in Japan and knew the same would happen in the West after 2008. He explains the processes at work in the Japanese economy since the 1990s, which are at now at work throughout the global economy.
Debt repayments to banks destroy money, this is the problem.
Japan had worked out how to kill growth and it was a recipe that was copied around the world.
The West isn’t as bad as Japan as we didn’t let asset prices crash, but it’s still the same problem.
It’s worse in the Euro-zone as they didn’t learn anything from Japan.
Austerity is the worst thing you can do in a balance sheet recession.
QE can’t get into the real economy due to a lack of borrowers.
The banks are ready to lend, but there are too few borrowers as they are struggling with the debt they have already taken on.
(We saved the banks, but left the debt in place like Japan)
QE can get into financial markets, so the gap between the markets and economic fundamentals widens and by 2019 the US stock market was at 1929 levels.
How can you kill growth in your economy?
In the 1980s, it looked as if Japan would take over the world, but bad financial practices have seen their economy flat-lining ever since.
Japanese companies found they could make more money from their financial arms (Zai Tech) than they could from their traditional businesses, for a while anyway.
House prices always go up and their real estate boom would never end, until it did.
Jusen were nonbank institutions formed in the 1970s by consortia of banks to make household mortgages since banks had mortgage limitations. The shadow banks were just an intermediary put in place to get around regulations.
Japan has never recovered.
This is the way you can knock out an economy for decades and was copied around the world.
Do all three, and leverage it up, and you can take out the global economy.
This is what Wall Street did in 2008.
“It’s nearly $14 trillion pyramid of super leveraged toxic assets was built on the back of $1.4 trillion of US sub-prime loans, and dispersed throughout the world” All the Presidents Bankers, Nomi Prins.
You need complex financial instruments to transmit the problems internationally.
These were more like a trigger, as the UK and Euro-zone were all set for a financial crisis anyway.
See graph at 25.30 above.
Italexit would benefit the vast majority of Italians, but not their oligarchs, so that’s not happening anytime soon.
Not sure if it would benefit their oligarchs or the italians. A land without a banking system since suddenly all debts outside of Italy are in Euro while you have to pay in Lira that is worthless, isn’t in the interest of the populace. Neither is a bankrupt state.
This article by Servaas Storm is in the footnotes to the main article. It is worth a read. The statistics that Storm marshals show how the EU’s neoliberal structures forced Italy into austerity–which the Italian elites were only to happy to cooperate in, because EU membership offered a kind of institutional stability that they believed was lacking in Italy. The result: An economy wrecked by neoliberal nostrums, impoverishment of labor, and austerity.