Zombie Arguments Against Fiscal Stimulus

January 20, 2021 Leave a comment

Busy days. I just want to drop a quick note on a piece just published on the Financial Times that is puzzling on many levels. Ruchir Sharma pleads against Joe Biden’s stimulus on the ground that it risks “exacerbating inequality and low productivity growth”. The bulk of the argument is in this paragraph:

Mr Biden captured this elite view perfectly when he said, in announcing his spending plan: “With interest rates at historic lows, we cannot afford inaction.”

This view overlooks the corrosive effects that ever higher deficits and debt have already had on the global economy. These effects, unlike roaring inflation or the dollar’s demise, are not speculative warnings of a future crisis. There is increasing evidence, from the Bank for International Settlements, the OECD and Wall Street that four straight decades of growing government intervention in the economy have led to slowing productivity growth — shrinking the overall pie — and rising wealth inequality.

If one reads the two papers cited by Sharma, they say, in a nutshell, (a) that expansionary monetary policies have deepened income inequality via an increase in asset prices (while for low interest rates and bond prices there is no clear link); (b) that the increasing share of zombie firms drags down the performance of more productive firms thus slowing down overall productivity growth.

So far so good. So where is the problem? Linking these results to excessive debt and deficit, to the “constant stimulus”, is stretched (and I am being kind). A clear case of Zombie Economics.

Let’s start with monetary policy and its impact on inequality (side note: the effect is not so clear-cut). One may see expansionary monetary policies as the consequence of fiscal dominance, excessive deficit and debt that force central banks to finance the government. But, they can also be seen as the consequence of stagnant aggregate demand that is not properly addressed by excessively restrictive fiscal policies, forcing central banks to step in. Many have argued in the past decade that especially in the Eurozone one of the causes of central bank activism was the inertia of fiscal policies. Don’t take my word. Read former ECB President Mario Draghi’s Farewell speech, in October 2019:

Today, we are in a situation where low interest rates are not delivering the same degree of stimulus as in the past, because the rate of return on investment in the economy has fallen. Monetary policy can still achieve its objective, but it can do so faster and with fewer side effects if fiscal policies are aligned with it. This is why, since 2014, the ECB has gradually placed more emphasis on the macroeconomic policy mix in the euro area.

A more active fiscal policy in the euro area would make it possible to adjust our policies more quickly and lead to higher interest rates.

This is as straightforward as a central banker can be: in order to go back to standard monetary policy making, fiscal policy needs to step up its game. Notice that Draghi also hints to another source of problems: the causality does not go from expansionary policies to low interest rates, but the other way round. We have been living in a a long period of secular stagnation, excess savings, low interest rates and chronic demand deficiency which monetary policy expansion can accommodate by keeping its rates close to “the natural” rate, but not address. Once again, fiscal policy should do the job.

Regarding zombie firms, it is unclear, barring the current and very special situation created by the pandemics, why this would prove that stimulus is unwarranted. The paper describes a secular trend whose roots are in insufficient business investment and a drop in potential growth rate (that in turn the authors link to a drop in multi-factor productivity). The debate on the role of fiscal policy in these matters is as old as macroeconomics. In the past ten years, nevertheless, the cursor has moved against the Sharma’s priors and an increasing body of literature points to crowding-in effects: especially when the stock of public capital is too low (as is the case in most advanced countries), an increase of public investment — “constant stimulus”– has a positive impact on private investment and potential growth (see for reference the most recent IMF fiscal monitor and the chapter by EIB economists of the European Public Investment Outlook). Lack of public investment is also widely believed to be one of the factors keeping our economies stuck in secular stagnation.

Fifteen years ago one could have read Sharma’s case against fiscal policy on many (more or less prestigious) outlets. Even then, it would have been easy to argue that it was flawed and fundamentally built on an ideological prior. Today, it seems simply written by somebody living in another galaxy.

The Question of Debt Sterilization is not for Today. But it Needs to be Discussed

December 11, 2020 Leave a comment

Yesterday I read an interesting FT piece (signed by the editorial board) arguing against debt cancellation. The piece is interesting and in my opinion its title (The case against cancelling debt at the ECB) is misleading. Summarizing, the piece argues that today countries like Italy have no market access problem, that spreads and interest rates are at an all time low, that debt cancellation would not free cash for Italian immediate needs. This are all reasonable arguments, but they would be relevant in assessing benefits of debt cancellation for a country facing a sovereign debt crisis. The current discussion on debt cancellation is nothing of that sort. It is more similar to debates that in the past were common after extraordinary shocks such as wars or… pandemics.

So, what is wrong with the FT way to approach the issue of debt cancellation (or sterilization, as I would prefer to call it for reasons to be clear below)? First, the excessive focus on Italy is off the mark. Any serious discussion on sterilizing the exceptional debt that was generated by the contrast to the pandemics should concern all EMU countries. All of them have had a spike in deficit and debt. Second, as I said, the piece focuses on the short run arguing that debt sterilization would not bring fresh cash. Of course it would not, and of course it would not be needed. EMU public debt is today (and for a long period to come) in excess demand. On top of that, we learned yesterday to no surprise that the ECB will keep the PEPP umbrella open for a while: March 2022 at the earliest, with no tapering to begin before 2023.

Thus, the discussion should not be on short term market access or liquidity needs (nor on the macroeconomic impact of debt sterilization in the current situation). Sterilizing the EMU pandemics-related public debt is a medium term issue, related to future fiscal space. The question to ask is whether the exceptional stock of debt that built in the past few months will constrain EMU countries in their ordinary fiscal policies in the future. If the answer is yes (I believe it is), then sterilizing that debt is eventually going to be an issue to be dealt with. And in that case it is hard to imagine that the ECB will not be part of the solution. In the end, this is what the FT editorial board seems to suggest too (this is why the piece is more nuanced than the title would make it believe), when they argue that

Italy could act by itself to make its debt easier to deal with over the long run, in case the ECB ever decides to sell its holdings back to the private sector and rates go up. In particular it could issue much longer dated debt to lock in the current low rate of funding, and gain more time to fix the country’s sluggish growth rate. Italy could even try to sell perpetual debt.

In short, the piece suggests that extending the maturity of debt (in principle to perpetuity) should be a strategy for the medium term. If the ECB were to buy that debt, we’d have monetization.

As a side note: The macroeconomic impact of cancellation and of monetization are alike. But cancellation poses a number of (mainly political) issues. I think it is wise to take it off the table and discuss pros and cons of a permanent increase of the ECB balance sheet size. Furthermore, I do not enter into the issue of monetization vs QE (that yielded “reservization”). That issue is very neatly addressed by my colleagues Christophe Blot and Paul Hubert (in French).

The FT editorial board then goes on with a discussion of helicopter money (making a link with debt write-off that I don’t quite see, but whatever) in managing deflationary pressures; once again the verbatim is instructive:

There may be monetary reasons to cancel government debt holdings. Many economists argue that “helicopter money” — a permanent increase in the money supply, likened by the economist Milton Friedman to central bankers dropping cash from a helicopter — will be necessary to rescue the eurozone from potential deflation. This would be most easily enacted by simply writing down the ECB’s existing holdings of government debt to zero. Any move towards this policy should come from central bankers keen to hit their inflation targets and not politicians playing with populist slogans.

What is interesting is the last sentence of the paragraph: The initiative should come from the ECB in pursuing its objectives, not from governments. I made the exact same point a couple of days ago (in Italian, unfortunately). Interestingly, the strong independence of the ECB in this case could help in making the one-off nature of monetization credible and to avoid triggering expectations of fiscal dominance.

So in the end the FT editorial board case against cancellation boils down to timing and to the opportunity that politicians (especially Italians) bring it up now. But the FT acknowledges that the issue of dealing with the Covid related extra debt is on the table and that some sort of ECB sterilization of that debt may in the future be part of the equation.

I am perfectly fine with this article. In spite of the title!

The ECB Umbrella is here to stay

November 11, 2020 Leave a comment

On December 10th the European Central Bank Governing Council will likely announce new measures to support governments that have to reach to their wallet again to try to cope with the economic effects of the pandemic second wave. It would not be surprising that the ongoing asset purchase programmes will be extended in size and duration (currently, the Pandemic Emergency Purchase Program, PEPP, is scheduled to run until June 2021). There have been rumors in recent days that the ECB could use this increase in its firepower to put pressure on countries that do not wish to make use of loans from the Recovery Fund and the ESM. ECB board member Yves Mersch yesterday also suggested that the ECB walk that path.

For those who are not into the European debate, it should be recalled that using the loans from European programmes (the ESM covid line, the SURE, and the quota of the Recovery Fund that is not grants) yields savings in interests: the EU will borrow on the markets at more favourable costs than many Member States and redistribute the amounts. If market rates are low, the gain in interest from European loans is reduced and may not be sufficient to offset the fact that these loans come with terms and conditions (and further problems in the case of the ESM). By reducing its purchases of reluctant countries’ assets, the argument goes, the ECB would raise market rates and thus make it convenient, if not inevitable, for them to use financing from European programmes.
I believe that it is very unlikely, if not impossible, that the ECB would engage in such nudging. Its umbrella will remain open for all eurozone countries for a long time to come. Instead of worrying about the presumed unsustainability of the debt that all European countries are accumulating, we should focus on how to spend the money quickly and well. Sustainability depends more on this than on unlikely ECB pressures or unlikely sudden reversals of market confidence.


There are three reasons to doubt that the ECB will use its purchasing programmes to interfere in the financing choices of European Governments. The first reason is technical. Since the Quantitative Easing program started in 2015, purchases of each country’s securities have been proportional to the so-called capital key, the shares of EMU countries in the capital of the ECB, which in turn are linked to population and GDP. This self-imposed proportionality was the price to be paid to avoid that the purchases were concentrated on peripheral countries’ securities, allowing them to pass on their debt to the supposed frugals through the ECB. When last March the new emergency purchase programme was introduced, the ECB relaxed the capital key so that purchases could initially focus on the debt of countries subject to market pressure and (contrary to what Lagarde has suggested just days before) keep spreads under control. However, even in this case, the ECB did not embrace complete discretion, as flexibility was only temporary: at a later stage purchases will have to be rebalanced in order to respect the self imposed proportionality at the end of the programme. Deciding now to move away from the capital key to put pressure on countries that do not want European loans would most likely meet the opposition of the core countries, that feel protected by them. It is interesting that Mersch himself, a few days before suggesting proportionality were scrapped to nudge Member States into EU loans, argued in an interview that “We are bound not by self-imposed limits but by red lines which are of a constitutional nature and which are in the treaty. The self-imposed limits only serve to respect those constitutional limits, which are not at our disposal.”

The second reason why ECB nudging is unlikely has to do with the current macroeconomic situation. One might in fact argue that, pretty much as in the current PEPP, flexibility and nudging could happen in the short run to eventually restore the capital key. But contrary to what many believe, today the ECB necessary to keep rates low. The crisis has generated an enormous mass of savings which, given the economic uncertainty, has mostly been channeled into demand for public debt of all countries. In October’s auctions alone Italy, one of the most problematic EMU countries when it comes to public finances’ sustainability, placed debt at different maturities (with rates close to zero) for around 33 billion euros against a market demand of more than 55 billion euros . Of course, it would be foolish to neglect the role of monetary policy: the ECB’s umbrella has contributed to making public debt safe and therefore attractive. But it is certainly not the only factor; the abundance of savings is increasingly a feature (and a problem) of our economies.
Last, but not least, political reasons, that encompass all th others, reduce the risk of ECB interference in countries’ financing choices. Since 2012, while it has struggled to convince markets of its credibility in sustaining growth and keeping inflation close to its target, the ECB has been very effective in curbing speculation. Ever since Mario Draghi’s 2012 whatever it takes speech, all it took to stop market pressure on peripheral countries, was the certainty that the ECB was ready to do everything (whatever it takes) to prevent speculative attacks to keep markets at bay, make public debt attractive and reduce spreads. A sort of (imperfect) lender of last resort, in sum. Even the PEPP programme, after some massive initial purchases, has settled on limited flows and proportionality is already almost restored. It is frankly quite implausible that the ECB will deliberately risk to increase uncertainty and let spreads widen again, squandering an hard-earned credibility capital just to push hesitant countries to apply for loans from European programmes.


Long story short, the ECB’s umbrella is set to remain open for a long time to come and will contribute, along with the mass of savings in search of placement, to keep the cost of debt low. We should resist getting entangled in the debate on how to finance (and repay) public debt, and focus on the use of the resources available. European countries need to efficiently invest in tangible and intangible infrastructures that will enable us to set out on a path of sustainable and sustained growth. After all, a healthy economy is the best guarantee of sustainable public debt.

There is no Trade-off. Saving Lives is Good for the Economy

March 29, 2020 1 comment

At the beginning of the COVID pandemic, when policy makers were struggling to find ways to cope with a crisis that most of them had under estimated, the public discourse was dominated by a trade-off: should we shut down economic activity to enforce/facilitate social distancing and curb the pandemic curve before it leads to the collapse of health care systems, and to deaths by the hundreds of thousands? Or should we just let the death toll be what it has to be, and let the virus pass through our countries (build “herd immunity”), avoiding severe economic consequences? To put it somewhat brutally, should we save lives or the economy? This trade-off certainly is in the minds of most governments, even if most of them carefully avoided letting it surface in their public discourse. The countries that stopped the economy justified it as the price to pay “to save lives”; just a handful of governments made it explicit that they had made the opposite choice. The most reckless undoubtedly was Boris Johnson who initially argued that the best strategy was to build herd immunity by letting the virus reach 4O millions people, whatever the cost in human lives would be. Trump and Bolsonaro (a merry fellowship indeed) had a very similar stance, minimising the cost at first, and then arguing that the economy should not be stopped. But many other countries in Europe, with the same trade-off in mind, delayed going into lockdown in spite of Italy spiraling into the crisis just around the corner. They simply were less impudent than the British PM, while considering the same strategy.

It is reassuring that for most countries reality (and opinion polls) caught up, so that strategies eventually converged to giving priority to the health crisis over the economy: more or less compulsory social distancing, and the freeze of economic activity are now generalized, with almost half of the world population under lockdown.

This is reassuring not only because priority should be given to saving human lives. But also because, as I have always believed, the trade-off between public health and the economy is complete nonsense. I was glad to read a piece by Luigi Guiso and Daniele Terlizzese (in Italian) making this point. I just wish that they (or somebody else, including myself) had made it before. This would have been an immensely more valuable contribution by economists, than playing epidemiologists and fitting exponential curves on social networks (I never did!).

But why is the trade-off nonsense? Simply put, because the pandemic will cause enormous harm to the economy, whether it claims lives by the millions or not. Suppose the BoJo initial strategy was implemented, and a few dozens millions of British people were infected, many of them for several weeks. Abstracting from fatality rates, labour supply would drop for months, and disruption in production would follow. Fear of contagion would limit social interaction (a sort of self-imposed confinement) for many, impacting consumption, investment, but also productivity. Some sectors (travel, tourism, services) would see significant drops in activity. The global value chains would be disrupted, and trade would take a hit. Furthermore, the collapse or near-collapse of health care systems would impact the quality of life (and sometimes cause the death) not only of those affected by the virus, but also of the many that in normal times need to resort to health care services. Consumer confidence and corporate sentiments would remain low for months, consumption and investment would stagnate, government intervention would be needed as much as it is needed in the lockdown. Last, but not least, the heavy toll paid to the pandemic crisis would impact human capital (think of casualties among doctors), and thus productivity and growth in the long run.

A slowdown would therefore be inevitable, a harsh one actually. But still, it could be argued that such a scenario would not be worse than the total halt we are experiencing. I beg to disagree. Let me go back to Mario Draghi’s piece in the Financial Times. The former ECB boss there argues that the urgent task of policy makers is to keep the businesses that are short of liquidity afloat whatever it takes, so that when the rebound will happen, the productive capacity will be able to provide goods and services, and incomes will recover quickly. Said it differently, if policy makers manage to minimize permanent damage to the supply side of the economy, a short lived shock, however brutal, might leave few scars.

But there is more than that. In fact, the minimization of permanent damage becomes harder and harder, and probably costlier and costlier, the longer the crisis is. Following the crisis of 2008-2010, an interesting literature developed on the permanent effects of crises. This literature highlights how long and low-intensity slumps have an impact through hysteresis on the capital (human and physical) of the economy and permanently lower the potential growth of the economy. The conclusion to be drawn from this literature is that the risk of letting the economy in a slump for too long, and hence suffer permanent damage, is larger than the risk of over reacting in the short-run.

Applying this mindset to the current pandemic dispels once and for all the trade-off; more than that. It allows to rank the two policy options. Doing whatever it takes to save lives is causing a deep and hopefully short-lived economic slump. However devastating for the economy, such a slump is much easier to manage for policy makers than the (maybe) marginally milder recession but spread over a longer period of time, that one would have by not imposing a total lockdown of the economy. Shutting down the economy saves lives, AND it is better for the economy. A no brainer, in fact.

Even the most cynical among our leaders should understand this: Saving as many lives as possible is the best we can do to save the economy and their chances of reelection.

Lagarde: A Rookie Mistake?

March 12, 2020 Leave a comment

So the ECB has spoken in response to the Coronavirus crisis, and it was a problematic response to say the least. I watched Christine Lagarde’s Q&A with journalists, which as usual was the most interesting part of the press conference. But boy, I wish today it had not taken place…

The bottom line is that Lagarde made a huge misstep in stating that the ECB is not going to close the spreads. I hope it is just a communication misstep, otherwise Italy (and probably other countries) will pay a heavy price.

But let’s see what happened today.

First, there is an attempt to put on the Eurozone governments’ shoulders most of the burden of reacting to a shock that will be “significant even if temporary”. Lagarde said clearly, towards the end of the press conference, that what she fears most is insufficient fiscal response coming out from the Eurogroup meeting next Monday:

It is hard to disagree with this approach. To target firms’ liquidity problems one cannot count on banks alone, (especially in countries where they have still not completely recovered from the sovereign debt crisis). As a side note, I welcome the provisions contained in the Italian €25bn package, such as the temporary lifting of short-term businesses obligations towards the government (VAT, social contributions, taxes). These seem to be the right measures to ease short term liquidity constraints.

But let’s look into what the ECB itself commits to do. Besides technicalities that I did not study yet, there will be two sets of measures:

  1. The first set concerns (continued) provision of cheap liquidity to banks, in order to ensure continuing supply of credit to the real economy. This will be ensured through a new and temporary long-term refinancing scheme (LTRO), together with significantly better terms for the existing targeted loan programs. This amount to a large subsidy to banks. Loans conditions will be more favorable for banks lending to Small and Medium Enterprises, which are the ones more likely to become strapped for liquidity in the current situation. Furthermore, as a supervisor, the ECB engages in operational flexibility when implementing bank specific regulatory requirements, and to allow full utilization of the capital and liquidity buffers that financial institutions have built. I am unclear on how much this will work in order to keep the flow of credit flowing, but overall, my sentiment is that on cheap and easy financing to banks and (hopefully) to firms, there is little more ECB could do.
  2. The second set of measure is a ramping up of QE, with additional €120bn (until the end of the year). Lagarde seemed to suggest that the ECB could use flexibility to deviating from capital keys, the quota of bonds the ECB can buy from each country. This means that maybe more help will be given to countries like Italy, and the ambiguity was probably on purpose.

But then came the Q&A, and with it, disaster. At a question by a journalist on Italian debt and yields, Lagarde replied the following:

This also made it on the ECB twitter feed:

This simple sentence was a reversal of Mario Draghi 2012 “whatever it takes“. Mario Draghi, in 2012, had basically announced that the ECB would act as a crypto-lender of last resort (conditional, way too conditional, but still), and since then the scope for speculation has been greatly reduced. Spreads have been much less variable since then (I wrote a paper with Roberto Tamborini, on that, that just came out).

Protection from the ECB against market speculation is what countries like Italy would need most. Fiscal policy is the tool that can be better targeted towards supporting the supply side of the economy and preventing liquidity problems from evolving into bankruptcies. Lagarde herself stated it many times in the past few days, and again today.

So, governments should be put in the conditions not to worry, at least for a while, of market pressure. Lagarde should have said the exact opposite: “we commit to freezing the spreads for n months so that governments can focus on supporting their productive sector, and restoring more or less normal aggregate demand conditons”. Lagarde said the opposite. And here is the effect of that on Italian ten year rates. Look what happened at around 3pm, when she answered the question:

The yields Other Eurozone peripheral countries had similar behaviours. Why did Lagarde say that? Maybe Because she wanted to appease fiscal hawks ahead of the Eurogroup meeting of next week, so that they are more willing to agree on a fiscal stimulus? Or because she was afraid to be accused to be too soft on Italy? Or to actually care about one single country, which is what the ECB is not supposed to do? Or was it simply a communication misstep? A rookie mistake? Whatever the reason, it is clear that Lagarde made a huge mistake, and even apparently she partially backpedaled in a NBC interview shortly thereafter, this is what remain of today’s press conference.

So, my assessment of today’s ECB move is mixed. It was as good as it gets on financing the banking sector, and we just have to cross finger that this is enough to keep credit flowing.

But it is disappointing on the support of expansionary fiscal policies. All the more disappointing that the ECB and Lagarde have insisted on the need for a fiscal response “first and foremost”.

My only hope is that that was a misstep, or just lip service to fiscal responsibility. If market pressure prevents governments from supporting their firms, and if liquidity problems evolve into solvency problems, a “significant but temporary” shock will become a permanent hit to long-term growth capacity. And let’s not forget that the Eurozone economy is today more diverse and less resilient than it was in 2008.

Brace yourself

ps. You can find my live tweeting during the Q&A (a bit confused at times. Live tweeting is not my thing!) here:

Squeezing a Balloon

September 26, 2019 Leave a comment

Via the Financial Times I have read the Asian Development Bank Asian Development Outlook 2019 Update. The outlook has an interesting section on the impact of the US-China trade war on the region. Let me simply quote the relevant paragraph: “Recent trade data also provide evidence of trade redirection. In the first 6 months of 2019, US imports from the PRC fell by 12% from the same period in 2018. At the same time, US imports from the rest of developing Asia rose by about 10%, with notably large increases of 33% for Vietnam; 20% for Taipei,China; and 13% for Bangladesh” (page 14). I also copied and pasted the figure in the following page:

This was to be expected. Of course trade diversion is not automatic, nor costless. Supply chains need to be reorganized, bottlenecks may appear. But it is obvious that as long as US demand for the goods produced abroad remains strong, if the price of these increases in China, the demand will look elsewhere. Now, the US has been recording substantial negative net lending (the sign of an excess of domestic demand over supply) since at least the early 1990s:

The source of this excess demand has not always been the same. Sometimes corporations, rarely households (most notably in the run-up to the crisis), and most of the times the government.

In particular, in recent years households have experienced excess savings, initially joined by corporations which then gradually went to equilibrium. The government is keeping demand high, and as a consequence the trade deficit alive.

The tariffs on China, in this context, are just like squeezing a balloon. As long as US domestic demand remains strong, compressing Chinese imports simply pops imports from Vietnam, or Bangladesh, or who knows what other country next. As long as American excess demand will persist, somebody elsewhere will provide the supply for it. Reducing bilateral trade deficit with China is not a solution to persistent excess domestic demand.

Of course, the US could impose barriers to imports from all countries. This would solve the problem and reduce the trade deficit. Higher import prices and competition between households, firms and the government, would reduce purchasing power and, together with excess domestic demand, the welfare of American voters. Mr. Trump should try this before November 3rd, 2020.

My Two Cents on the “Yellow Vests” Movement

December 12, 2018 1 comment

In a widely commented televised address President Macron  has made a last-minute attempt to stop the “yellow vests” wave, that is investing France and his presidency. After a dramatic (a bit too much to seem sincere, if you ask me) mea culpa on past arrogance, and a promise to “listen to the suffering of the people”, Macron announced a few changes to the French budget law, to sustain the purchasing power of the lower part of the income distribution. The most important and immediate changes are: an increase of minimum wage (more precisely of the “employment subsidy” that is given to most people working at or around minimum wage): the exemption from taxes and social contribution of extra hours (a very popular measure that had been introduced by Nicolas Sarkozy and later abolished by François Hollande); and last but not least, the repeal of the increase of social contributions for retirees, and the confirmation of the freezing (for at least the year 2019) of the “ecological tax” on fuel. Macron also signaled the intention to backtrack on his vertical leadership style (the président jupitérien); he pleaded for renewed role for intermediate bodies (most notably the mayors and local politicians) in putting in place a concerted effort (a “social compact”) to boost growth and social cohesion.

Will Macron’s announcement appease the uprising that inflames France? Most probably not, because they suffer from an original sin, a contradiction that the President is unwilling (or incapable) of seeing. The yellow vest protest originates from the gas price increase, that affected rural households and farmers in particular? But the malaise has much deeper roots, that are widespread. The French economy feels, after ten years, the full weight of a crisis that has hit very hard the middle and lower classes: Unemployment that fell too slowly  (costing re-election to François Hollande ; austerity that, although less marked than in the peripheral eurozone countries, has reduced the perimeter and coverage of public services and of the welfare system, while increasing the tax burden; and, finally, the reduction of family allocations and welfare in general, which particularly affected the most disadvantaged categories. All of this led to what Julia Cagé, on French daily Le Monde, called “the purchasing power crisis”, that simmered for a long time, before exploding in the past weeks.

Emmanuel Macron has an enormous responsibility for the bursting of the crisis. True, the increase in the tax burden for the middle class is mainly due to François Hollande (under the impulse of an ambitious undersecretary, and then minister of the economy, named … Emmanuel Macron). One might even argue that the budget law for 2019 reverses the trend as that the reduction of some taxes (in particular the elimination of the housing tax for the majority of households, and the flat tax on capital income) has more than offset the reduction in social benefits.

What explains then the fact that the discontent emerges, so violently, just now? The explanation is simple: it is to be found in the approach that the French President pursued since he beginning of his mandate. Like Donald Trump, with whom he disagrees on almost everything, Emmanuel Macron believes in the so-called “trickle down” theory: shifting the tax burden away from the rich is the best strategy to revive growth, because these people are more productive than the average, and invest the extra income in innovative activities. The fruits of higher growth would then percolate to everyone, even those who were initially penalized by the tax reform. From the beginning of his mandate, Macron’s choice to give France a pro-business image was clear, leading to a drastic reduction of taxes on the richest, and making the taxation, for the upper part of the distribution, fundamentally regressive.

The last budget law represents the clearest proof of this approach. The “Institute for Public Policies” has shown (see the figure, taken from a Le Monde article appeared last October) that while the overall disposable income slightly increases, the bottom 20% and the upper-middle class see a substantial worsening of their situation, while the very rich (the top 1%) see their purchasing power increase of 6%.

2018_12_12_Macron

The problem is, as an increasing body of evidence shows, that trickle down does not work. Favoring the richest does not increase productive investment (it rather tends to boost non-produced asset prices and unproductive consumption), and the impact on growth is both negligible and not shared; these days’ demonstrations stand to prove it. History cannot be rewritten, but the attempt to twist the tax system in favor of the ecological transition would probably have been met with much more enthusiasm, in a country like France where environmental awareness is high, where it not accompanied by the sentiment of increasing social injustice that Macron’s economic policies have deepened.

It is interesting to notice, in this regard, that traditional media have given a somewhat distorted image of the protest movement (which is very hard to clearly decrypt). A group of researchers from Toulouse University uses lexicographic analysis to show that the narrative of traditional media was centered on revolt against taxes (ras-le-bol fiscal), and therefore in contradiction with the request of better public services;  this does not correspond to the message coming from social networks that organized “from the bottom” the movement, in which instead the predominant mood was revolt against social injustice and against the elites that grow richer and richer, while leaving the check for the others to pay. To sum up, a plea for a more equal and cohesive society.

How will this end? It is hard to say. The yellow vests have obtained a partial win, with the freezing of the gas increase, and with the measures announced by Macron on Monday. But it is unlikely that we will see a substantive change of economic policy, precisely because of the President’s views outlined above. He rushed to rule out any reinstatement of the wealth tax, because “in the past unemployment increased even when the wealth tax existed” (a rather unconvincing argument, to say the truth).

If higher incomes are not called to contribute to the effort (towards ecological transition, but more generally towards the financing of the French social model), even the measures just announced will have a very limited impact. The State will somehow have to take back with one hand (for example by reducing public services, that benefit lower income most, or increasing other taxes) what it just handed out with the other hand. The demand for social justice that confusedly emerges from the yellow vests movement will once more go unanswered, leaving untouched the tension that is ripping the French (and not just the French) society.

To meet these needs, a new political proposal would have to put the complex theme of the redistribution of resources in a globalized world at the center of its project. It would be necessary to rediscover the “Regulatory State” which, in the golden years of social democracy (and of the social right), guaranteed social and macroeconomic stability, and thus laid the foundations for investment, innovation, and growth. That role is more difficult to define in a globalized world in which individual States have limited room for maneuver, and in which therefore international cooperation, however difficult, is now the only way forward. But this challenge can not be avoided if we do not want movements such as those of yellow vests to fall prey to nativist autocratic populism.

 

(This is the translation of a piece I published in Italian on the Luiss Open website)

Could Central Banks do More during the Crisis?

September 7, 2018 3 comments

I rarely disagree with Martin Sandbu’s Free Lunch. But today’s piece on central banks is one of these cases.

In short, Martin argues that while the main culprit for the slow recovery is fiscal policy, almost everywhere too timid if not outright procyclical (we are all on board on that!), the mistakes of fiscal authorities do not exempt central banks from bearing part of the responsibility. In particular, he dismisses the claim that it was technically impossible to lower long-term interest rates further, and/or bring policy rates even more into negative territory.

I agree with this point. Interest rates could have been lowered further. Nevertheless, I think that this would have made very little difference, because after 2008 central banks were essentially pushing on a string.  This point of disagreement between us can be traced to a different view about what is the liquidity trap.

I recently published a book, La Scienza inutile (a general public account of a century of debates in macroeconomics. For the moment it is in Italian and in French, English translation in progress), in which I discuss the different notions of liquidity trap. Here is the quote (sorry, a bit too long):

 The first source of trouble that Keynes considers is the most extreme, the so-called liquidity trap: `There is the possibility, […] that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest’ (Keynes 1936, p.207). In slightly more technical terms, the interest elasticity of money demand is near-infinite: no matter how much liquidity the central bank injects into the economy, it is entirely hoarded by agents and hence it leaks out of the system in its entirety. Monetary expansion is not effective in lowering interest rates.

There may be different reasons why the economy enters a liquidity trap. Keynes argued, by looking at the great depression, that this usually happens at very low (but not necessarily nil) levels of the interest rate, because in this case agents would expect interest rates to rise in the future and thus would be willing to hold any extra amount of money and postpone the purchase of bonds to the moment when interest rates will be up again. More recently the liquidity trap has been defined as a situation in which the interest rate that equates savings and investment is negative, and therefore cannot be attained by the central bank (the so-called Zero Lower Bound, or ZLB; see e.g. Krugman 2000). This latter definition leaves some room for monetary policy effectiveness: if the central bank manages to trigger the expectation of positive inflation, the real interest rate (the nominal interest rate minus the inflation rate) will become negative and lead to the full employment equilibrium.

So, if we think in terms of ZLB, it exists a real interest rate at which the output gap would be closed. If that interest rate is negative, then it is harder to reach, as central banks need to raise inflation expectations and try to push short term rates as much as possible in negative territory, which requires boldness and creativity (we have seen this). But, once again I agree with Martin on that, this can be done. If instead private expenditure becomes irresponsive to interest rates, the ‘Keynes definition’, then there is little central banks could do. I had noticed, back in 2016, that while it succeeded in easing credit conditions, EMU Quantitative Easing seemed to have done little to boost confidence and expected demand (the ultimate driver of firm’s credit needs). The EMU most recent Bank Lending Survey seems to confirm the prediction of the time. Both chart 4 (enterprises) and chart 12 (households) depict a flat demand for loans, that picks up only when the EMU economic outlook brightens.

This is by no means hard evidence (I am not aware of any papers thoroughly investigating the impact of QE on credit demand). But stylized facts seem to acquit central bankers.

 

 

ps

The two works cited in the quote:

Keynes, J. M. (1936). The General Theory of Employment, Interest, and Money. London: McMillan.

Krugman, P. (2000). Thinking About the Liquidity Trap. Journal of the Japanese and International Economies 14(4), 221–237.

Democratising Europe begins with ECB nominations

January 30, 2018 1 comment

I repost here a post from Thomas Piketty’s Blog, originally published as an op-ed on Le Monde, which I was happy to sign.
This collective op-ed was initially published on January 22 2018 in Le Monde (in French) and in VoxEurop (in English).

While our eyes are glued to the interminable vicissitudes of the German Groko, a no less important story is playing out in Brussels, but has so far met with indifference. On January 22nd and February 19th, Eurogroup finance ministers will hold private meetings that will mark the beginning of a profound renewal of the European Central Bank executive board. The first big change will be the planned replacement of current Vice-President, Vitor Constancio. In the next two years, no less than 4 of the 6 members of the executive body of the ECB, Mario Draghi included, will be replaced.

All signs indicate that the future of economic, fiscal and monetary policy in eurozone countries is at stake in this series of nominations. The ECB of 2018, after all, barely resembles that earlier organisation which spent its relatively quieter days at the periphery of European policy, protected by its independent status. Built by governments and financial markets as an institutional recourse, the ECB started wielding more power thanks to the 2008 economic and financial crisis. Whether it’s telling member states how to finance their market debts, suggesting the adoption of a budgetary treaty (Fiscal Compact), notifying Irish or Italian heads of state that they should undertake without delay a raft of onerous reforms, or directly intervening in negotiations on the Greek crisis by controlling access to liquidities, it is always as a veritable co-ruler of the eurozone that the ECB operates.

After a decade of crisis, the ECB is no longer the same institution that was drawn up by the Treaties and consecrated to the sacro-saint goal of price stability: it has established itself, estimates at the ready, as Chief Economist of the eurozone; it has acquired executive power via the troika (with the European Commission and the IMF), which defines and ensures the execution of memoranda in countries being “helped”; it plays a central role in eurozone and Eurogroup summits which coordinate national economies; it has become a regulator of the banking world, deciding on the life and death of the largest banks in the eurozone; it has established itself as a reformer, working with coalitions built on prioritising “structural reforms” (labour markets), “competitiveness” (restrictive salary policies), etc.; it speaks on equal terms with the four other “presidents” of the Union (of the Commission, the Council, Eurogroup, and, finally, the European Parliament) when it comes to designing the political and institutional future of eurozone government, etc.

And yet, it as if the coming nominations are just another technicality. While there is in fact a rare occasion for leading parties and actors of representative politics to make their weight felt on the crucial issue of eurozone governance, everything seems set to keep nominations behind closed doors. Finance ministers are wary of having their decisions in Brussels held to account by their national parliaments; Eurogroup, an institution barely recognised by European treaties but which in fact plays a decisive role in the matter, has no form of political control. As is often the case, the European Parliament, which will hold a hearing for the chosen candidate, will arrive after the dust has settled, after negotiations have been concluded and compromises have been accepted, to give its… consultative opinion.

Meanwhile, there’s no lack of questions concerning the future of ECB policies and the role it should play: what position should it take in the reform of eurozone governance? What will its commitments be with regard to the European Parliament? What will become of its monetary policy when inflation has disappeared? What support can to bring to the Union’s policies? What are its priorities for the next eight years in terms of banking regulations? What place will be given to social partners? What form of policy will there be against conflicts of interest for the banking regulator? What redistributive effects can we expect from ECB policies? No doubt, the responses to these questions will determine the future course of the government of the eurozone. Candidates need to be questioned, and their responses should be known and debated.

Financial markets and governments seem satisfied with the current situation, happy to throw a veil of ignorance over the nomination process. And the signals coming from Brussels are hardly reassuring, leading us to suspect that Spain, imagining that its time has come, will propose it’s current minister for the economy, Luis de Guindos, for the vice-presidency on January 22nd. One of de Guindos’s main claims to fame is having been the executive president for Spain and Portugal’s branch of the Lehman Brothers during the peak of the financial crisis…

In the absence of the eurozone parliamentary assembly called for in the treaty for the democratisation of the eurozone (T-dem), of which one function would be precisely the political supervision of ECB nominations, there is still nothing preventing finance ministers from making public the criteria which justify their preferences for this or that candidate, and the conditions they want to impose on them.

The nomination process does not have to be conducted in private. It doesn’t have to be yet another game of European musical chairs. Nothing, in effect, is stopping finance ministers from making their decisions, and the reasons behind those decisions, public. Nothing is stopping candidates, those for the presidency most of all, from stepping forward in the coming months, being heard by national representatives, and stating their commitments.

And nothing, finally, is stopping the European Parliament from making its participation in the nomination process conditional on its own basic political requirements. This is how European parties, unions and NGOs can cut a path and begin weighing in on the decisions which will decide economic, fiscal and monetary policies within the eurozone. This would be the first real step – however modest – towards the democratisation of Europe.

Last September, in Athens, Emmanuel Macron called emphatically Europe to bring more « democracy, controversy, debate, building through critical spirit and dialogue ». It is now time that words and deeds go hand in hand.

First signatories :

Sébastien Adalid, jurist, professer at the University of Le Havre

Michel Aglietta, economist and professor emeritus at the University of Paris Nanterre

Peter Bofinger, economist, professor at Saarland University

Loïc Blondiaux, political scientist, professor at the Paris 1 University

Julia Cagé, economist, professer at Sciences Po, Paris

Amandine Crespy, political scientist, professor at the Université libre of Brussels

Anne-Laure Delatte, economist, director of research at CNRS

Bastien François, political scientist, professor at the University of Paris 1

Ulrike Guérot, political scientist, professor at the Danube University

Stéphanie Hennette, jurist, professer at Paris Nanterre University

Justine Lacroix, political scientist, professor at the Université libre of Brussels

Rémi Lefebvre, political scientist, professor at the University of Lille 2

Nicolas Leron, political scientist, think tank EuroCité

Ulrike Liebert, political scientist, professor at the Bremen Univeristy

Paul Magnette, political analyst, mayor of Charleroi

Francesco Martucci, lawyer, professor at Paris 2 University

Thomas Piketty, economist, director of studies at EHESS

Ruth Rubio Marín, lawyer, professor at Sevilla University

Guillaume Sacriste, political analyst, lecturer at Pantheon-Sorbonne University

Francesco Saraceno, economist, OFCE

Frédéric Sawicki, political scientist, professor at the University of Paris 1

Laurence Scialom, economist, professer at Paris Nanterre University

Xavier Timbeau, economist, principal director of OFCE

Antoine Vauchez, political analyst, director of research at CNRS

Translated by Ciaran Lawles

Public Debt. I can’t Believe we are Still There

January 25, 2018 3 comments

The crisis is supposedly over, as the European economy started growing again. There will be time to assess whether we are really out of the wood, or whether there is still some slack. But this matters little to those who, as soon as things got slightly better, turned to their old obsession: DEBT! Bear in mind, not private debt, that seems to have disappeared from the radars. No, what seems to keep policy makers and pundits awake at night is ugly public debt, the source of all troubles (past, present and future).

Take my country, Italy. A few days ago this tweet showing the difference between the Italian and the German debt made a few headlines:

 

The ratio increased, so DEBT is the Italian most pressing problem. Not the slack in the labour market. Not the differentials in productivity. I can’t stop asking: why aren’t Italians desperately tweeting this figure?

2018_01_25_Public_Debt1

This shows the relative performance of Italy and Germany along two very common measures of productivity, Multifactor productivity and GDP per capita. I took these variables (quick and dirt from the OECD site), but any other measure of real performance would have depicted a similar picture.

So what? The public debt crusaders will argue that precisely because of debt, Italy has poor real performance. The profligate public sector prevented virtuous market adjustments, and hampered real convergence.  The causality goes from high debt to poor real performance, they will argue. Reduce debt!

Well, think again. Research is much more nuanced on this. A paper by Pescatori and coauthors shows for example that countries with high public debt exhibit high GDP volatility, but not necessarily lower growth rates. High but stable levels of debt are less harmful than low but increasing ones. In a recent Fiscal Monitor the IMF has shifted the focus back to private debt (which, it is worth remembering is the root cause of the crisis), arguing that the deleveraging that will necessarily continue in the next few years will require accompanying measures from the public sector: on one side, renewed attention to the financial sector, to make sure that liquidity problems of firms, but also of financial institutions) do not degenerate into solvency problems. On the other side, the macroeconomic consequences of deleveraging, most notably the increase of savings and the reduction of private expenditure, may need to be compensated by Keynesian support to aggregate demand, thus implying that public debt may temporarily increase in order to sustain growth (self promotion: the preceding paragraph is taken from my book on the relevance of the history of thought to understand current controversies. French version available, Italian version coming out in March, English version coming out eventually).

In just a sentence, the causal link between high debt and low growth is far from being uncontroversial.

Last, but not least, it is worth remembering that Italy was not profligate during the crisis; unfortunately, I would add.  Let’s look at structural deficit (since 2010; ask the Commission why we don’t have the data for earlier years), which as we know washes away the impact of cyclical factors on public finances.

2018_01_25_Public_Debt2

The Italian figures were slightly worse than the German ones, but not dramatically so. And if we take interest expenditure away, so that we have a measure of what the Italian government could actually control, then Italy was more rigorous (Debt obsessive pundits would use the term “virtuous”) than Germany.

The thing is that the Italian debt ratio is more or less stable, in spite of sluggish growth (current and potential) and low inflation. It is not an issue that should worry our policy makers, who should instead really try to boost productivity and growth. Said it differently, it is more urgent for Italy to work on increasing the denominator of the ratio between debt and GDP than to focus on the numerator. And I think this may actually require more public expenditure and a temporary increase in debt (some help from the rest of the EMU, starting from Germany, would not hurt). It is a pity that the “Italian debt problem” is all over the place.