Home > EMU Crisis, Fiscal Policy, Inequality, Wages > Supporting Aggregate Demand in Fiscally Constrained Economies

Supporting Aggregate Demand in Fiscally Constrained Economies

In the past weeks I have argued at length that  the eurozone is in recession because of a strong contraction of aggregate demand; and that in spite of this fact the overall fiscal stance is restrictive.

I also argued that in the current situation the best that can be hoped for peripheral countries is a more gradual consolidation (ideally a neutral stance, but this is too much to ask). I do believe that a fiscal expansion, even in the periphery, would be sustainable and growth-enhancing. But at this stage this is just daydreaming. It won’t happen.

The fiscal stance of the eurozone will not become expansionary (as is sorely needed), if the core (and in particular Germany) does not implement robustly expansionary fiscal policies.

If their fiscal space is limited or non-existent, what can peripheral countries do, besides waiting for an improbable fiscal stimulus in Germany? A lot, actually. If public demand cannot be significantly increased (and will actually be further compressed, albeit at a slower pace), it is all the more important that the governments of Italy, Greece, Spain and so on, find ways to restart private demand.

There is a lot of discussion about structural reforms. They are not the answer. First, because they have an impact mostly on supply (and the problem, let me repeat it, is demand); second, because their benefits, if any, won’t materialize before a few years. And there is no time. The cumulate effect of five years of crisis is now threatening social cohesion in most peripheral countries.

A more straightforward policy, that could be implemented in the next few months with immediate effects, is a strong redistribution of the tax burden towards higher incomes. The increasing inequality of income of the past three decades is in my opinion one of the deep causes of the crisis;  inequality has further increased since 2008. The squeeze of revenues for low incomes, coming from the combination of high unemployment and fiscal adjustment, is depressing both the capacity to spend and the morale of households. Increased inequality contributed to global imbalances in the past, and  is recessionary in the current crisis.

In September, when the season of budget laws begins, governments in the periphery should propose to their parliaments revenue-neutral tax adjustments, lowering taxes on low income households and increasing them on the rich and very rich. This would be fair, and more importantly, effective to boost morale and consumption. I am talking about a substantial shift of the burden, large enough for its macroeconomic impact to be significant. This is all the more necessary if standard Keynesian deficit spending can not be implemented.

  1. Marko
    June 6, 2013 at 9:37 am

    Revenue-neutral tax adjustments are precisely the tactic that highly-indebted countries should be using , most especially highly-unequal ones like the U.S.

    It’ll take another crisis or two before we see it , however. The rich are running the place in Europe and the U.S. and , to a large extent ,the working classes are cheering them on. Look at the response to Hollande’s attempts to tax the wealthy – as soon as a rich movie star moves away to avoid higher taxes , everyone wants Hollande’s scalp. Same in the UK with the 50% top rate.

    If it’s done at all , it won’t be done in size , as you recommend , because the beneficial effect would be obvious. A slight increase in taxes on the rich would result in a small benefit to the economy such that clever economists would , after much massaging of the data , redefine the benefit as a detrimental effect , and then say : ” See , I told you taxing the rich was a bad idea .”

    • June 6, 2013 at 10:48 am

      Totally agreed. I come to realize that many of my posts contain a good deal of wishful thinking…

  2. George J. Georganas
    June 6, 2013 at 11:31 am

    Arnaud Lechevalier, no friend of austerity, in this short publication http://pratclif.com/economy/alter-eco/modele-allemand.htm shows that the countries that reduced inequality the most before the crisis are the ones that are now in the greatest trouble, while the ones that increased inequality have fared considerably better.
    If, as you argue, the Eurozone has a demand problem, this could be due to reduced demand in the world markets for Eurozone exports. I, for one, cannot see much demand in China, or for that matter, Greece, for setting stamps on documents, which seems to have been the sector of the Greek economy that grew the most during the pre-crisis years. On the other hand, there is plenty of demand for Chinese goods in Greece, even in this time of crisis and mostly from low-income people. So demand reflation through redistribution will leak mostly to China with little effect on the domestic market.
    For a fuller development of this argument, one can see this :

  3. Gianni
    June 6, 2013 at 3:09 pm

    Weight of labour on GVA increased in Italy since 2007. Not diminished This is one of the problems we have since firms’ profit are squeezed and so do not invest. https://www.bancaditalia.it/pubblicazioni/relann/rel12/rel12it/app_12_totale.pdf (tav a9.5)

    in any case redistribution is an ideological hoax: taxes go to governments not to the poors

  1. July 8, 2013 at 11:20 am
  2. October 28, 2013 at 2:57 pm

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