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The Confidence Witch

Remember the old times? Here is a quote from ECB President Jean-Claude Trichet, September 2nd, 2010:

[Fiscal Consolidation] is a prerequisite for maintaining confidence in the credibility of governments’ fiscal targets. Positive effects on confidence can compensate for the reduction in demand stemming from fiscal consolidation, when fiscal adjustment strategies are perceived as credible, ambitious and focused on the expenditure side. The conditions for such positive effects are particularly favourable in the current environment of macroeconomic uncertainty.

And just in case it was not clear, on September 3rd, 2010:

We encourage all countries to be absolutely determined to go back to a sustainable mode for their fiscal policies,” Trichet said, speaking after the ECB rate decision on Thursday. “Our message is the same for all, and we trust that it is absolutely decisive not only for each country individually, but for prosperity of all.”

“Not because it is an elementary recommendation to care for your sons and daughter and not overburden them, but because it is good for confidence, consumption and investment today”.

Well, think again. Here is the abstract of ECB Working Paper no 1770, March 2015:

We explore how fiscal consolidations affect private sector confidence, a possible channel for the fiscal transmission that has received particular attention recently as a result of governments embarking on austerity trajectories in the aftermath of the crisis. Panel regressions based on the action-based datasets of De Vries et al. (2011) and Alesina et al. (2014) show that consolidations, and in particular their unanticipated components affect confidence negatively. The effects are stronger for revenue-based measures and when institutional arrangements, such as fiscal rules, are weak. To obtain a more accurate picture of how consolidations affect confidence, we co nstruct a monthly dataset of consolidation announcements based on the aforementioned datasets, so that we can study the confidence effects in real time using an event study. Consumer confidence falls around announcements of consolidation measures, an effect driven by revenue-based measures. Moreover, the effects are most relevant for European countries with weak institutional arrangements, as measured by the tightness of fiscal rules or budgetary transparency. The effects on producer confidence are generally similar, but weaker than for consumer confidence.

The confidence fairy seems to have turned into a confidence witch. One more victim of the crisis. But this one will not be missed.

It is not shameful to change opinion. Rather the contrary, it is a sign of intellectual courage. Two years ago, the IMF famously surprised commentators worldwide with a rather substantial U-turn on the impact of austerity. Revised calculations on the size of multipliers led them to acknowledge that they had underestimated the impact of austerity on economic activity.

Even at that time it started with a technical paper. But significantly, that paper was coauthored by Olivier Blanchard, IMF Chief Economist. It then served as the basis for a progress report on Greece, in June 2013, that de facto disavowed the first bailout program arguing that austerity had proven to be self-defeating.

Let us just hope that in the ECB new building communication between the research department and the top guys is more effective than in the old one…

I am glad to give credit for the title to Merijn Knibbe, from Real-World Economics Review Blog, who used the term in a comment to my last post.

  1. JF
    March 26, 2015 at 1:15 pm

    I assume they are referring to consumption-based taxation when this sentence appears: “Consumer confidence falls around announcements of consolidation measures, an effect driven by revenue-based measures.”

    Otherwise they may be trying to say that consolidation by cutting spending is OK, it is revenue raising that is the problem.

    I hope that the details of this working paper are clear. I also hope that the data implicate that confidence drops when consumption taxes are used to raise revenues – and this should be no surprise as it affects the bulk of society in everything they do. Just to be clear, perhaps the authors when they move this to publication can highlight that this is a demand-factor reaction (Keynes General Theory quote about consumption might be nice here) so the authors recommend that revenue measures look at other types of taxation, such as taxes whose incidence is directly tied to capital or income taxation as its surrogate (if they are comfortable with making recommendations).

    And note how the ECB’s Trichet was outright recommending fiscal policy before, so no reason not to make recommendations here – based on the evidence.

  1. April 15, 2015 at 10:47 am
  2. April 16, 2015 at 10:29 am
  3. May 27, 2016 at 7:07 pm

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