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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:

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.

Killing Them Softly?

December 15, 2016 1 comment

Just a very quick and unstructured note on Greece. There is lots of confusion under the sky, and it seems to me that creditors are today advancing in sparse order.

Yesterday something rather upsetting happened, as the Eurogroup suspended bailout payments because Greece engaged in some extra expenditures. These are mostly targeted to pensioneers and to the Greek islands that had to endure unexpected costs linked to the refugee crisis. Unexpectedly, the Commission is siding with Greece, with Pierre Moscovici arguing that the country is on target, and that its effort has been remarkable so far. In fact, I have understood, Greece is doing so well that it overshot the target of structural surplus for 2016, and it it these extra resources that it is engaging in order to soft the impact of austerity.

And then there is the IMF, accused by Greece of pushing for more austerity, is also under attack from EU institutions (Eurogroup and Commission) for its refusal to join the bailout package. The Fund has hit back, in a somewhat irritual blog post signed by Maurice Obstfeld and Poul Thomsen (not just any two staffers) and seems not to be available to play the scapegoat for a program that in their opinion was born flawed. In fact, I think that more than to Greece, Obstfeld and Thomsen have written with the other creditors in mind.

I have two considerations, one on the economics of all this, one on the politics.

  • I think I will side with the IMF on this. At least with the recent IMF. Since the very beginning The IMF has dubbed as irrealistic the bailout package agreed after the referendum of 2015 . The effort demanded to Greece (the infamous 3.5% structural surplus to be reached by 2018) was recognized to be self-defeating, and the IMF asked for more emphasis on reform, with in exchange a more lenient and realistic approach to fiscal policy: debt relief and much lower required suprluses (1.5% of GDP). In other words, the IMF seems to have learnt from the self-defeating austerity disaster of 2010-2014, and to have finally an eye to the macroeconomic consistency of the reform package. I still believe that the bailout should have been unconditional, and require reforms once the economy had recovered (sequencing, sequencing, and sequencing again). But still, at least the IMF now has a coherent position. Moscovici’s FT piece linked above also seems to go in the same direction, arguing that nothing more can be asked to Greece. It falls short of acknowledging that the package is unrealistic, but at least it avoids blaming the country. And then there is the Eurogroup, actually, Mr Dijsselbloem and Schauble (let’s name names), that did not move an inch since 2010, and fail to see that their demands are slowly (?) choking the Greek economy, stifling any effort to soften the hardship of the adjustment.
  • The political consideration is that the hawks still give the cards, as they dominate the eurogroup. But they are more isolated now. Evidence is piling that the eurozone crisis has been mismanaged to an extent that is impossible to hide, and that the austerity-reforms package that the Berlin View has imposed to the whole eurozone is a big part of the explanation for the political disgregation that we see across the continent. The more nuanced position of the Commission, the IMF challenge to the policies dictated by the hawks, therefore represent an opportunity. There is a clear political space for an alternative to the Berlin View and to the disastrous policies followed so far. The question is which government will be willing (and able) to rise to the occasion. I am afraid I know the anwser.

A Plea for Semi-Permanent Government Deficits

December 9, 2016 3 comments

Update (1/7/2016): The whole paper is now available on Repec.

I have recently written a text on EMU governance and the implementation of a Golden Rule of public finances. I will provide the link as soon as it comes out. The last section of that paper can be read stand alone (with some editing). A bit long, I warn you, but here it is:

Because of its depth, and of its length, the crisis has triggered an interesting discussion among economists about whether the advanced economies will eventually return to the growth rates they experienced in the second half of the twentieth century.
One view, put forward by Robert Gordon  focuses on supply-side factors. Gordon argues that each successive technological revolution has lower potential impact, and that in this particular moment, “Slower growth in potential output from the supply side, emanating not just from slow productivity growth but from slower population growth and declining labor-force participation, reduces the need for capital formation, and this in turn subtracts from aggregate demand and reinforces the decline in productivity growth.

In a famous speech at the IMF in 2013, later developed in a number of other contributions, Larry Summers revived a term from the 1930s, “secular stagnation”, to describe a dilemma facing advanced economies. Summers develops some of Gordon’s arguments to argue that lower technical progress, slower population growth, the drifting of firms away from debt-financed investment, all contributed to shifting the investment schedule to the left. At the same time, the debt hangover, accumulation of reserves (public and private) induced by financial instability, increasing income inequality (on that, I came first!), tend to push the savings schedule to the right. The resulting natural interest rate is close to zero if not outright negative, thus leading to a structural excess of savings over investment.

Summers argues that most of the factors exerting a downward pressure on the natural interest rate are not cyclical but structural, so that the current situation of excess savings is bound to persist in the medium-to-long run, and the natural interest rate may remain negative even after the current cyclical downturn. The conclusion is not particularly reassuring, as policy makers in the next several years will have to navigate between the Scylla of accepting permanent excess savings and low growth (insufficient to dent unemployment), and the and Charybdis of trying to fight secular stagnation by fuelling bubbles that eliminate excess savings, at the price of increased instability and risks of violent financial crises like the one we recently experienced.

The former IMF chief economist Olivier Blanchard has elaborated on the meaning of Summers’ conjecture for macroeconomic policy. If interest rates will remain at (or close to) zero even once the crisis will be over, monetary policy will continuously face the Scylla and Charybdis. The recent crisis is a good case study of this dilemma, with the two major central banks of the world under fire from some quarters, for opposiite reasons: the Fed for having kept interest rates too low, contributing to the housing bubble  and the ECB for having done too little and too late during the Eurozone crisis.

Drifting away from the Consensus that he contributed to consolidate, Blanchard concludes that exclusive reliance on monetary policy for macroeconomic stabilization should be reassessed. With low interest rates that make debt sustainability a non-issue; with financial markets deregulation that risks yielding more variance in GDP and economic activity; and with monetary policy (almost) constantly at the Zero Lower Bound, fiscal policy should regain a prominent role among the instruments for macroeconomic regulation, beyond the cycle. This is a very important methodological advance.

Nevertheless, in his plea for fiscal policy, Blanchard falls short of a conclusion that naturally stems from his own reading of secular stagnation: If the economy is bound to remain stuck in a semi-permanent situation of excessive savings, and if monetary policy is incapable of reabsorbing the imbalance, then a new role for fiscal policy may appear, that goes beyond the short-term stabilization that Blanchard (and Summers) envision. In fact, there are two ways to avoid that the ex ante excess savings results in a depressed economy: either one runs semi-permanent negative external savings (i.e. a current account surplus), or one runs semi-permanent government negative savings. The first option, the export-led growth model that Germany is succeeding to generalize at the EMU level, is not viable, except for an individual country implementing non cooperative strategies, because aggregate current account balances need to be zero. The second option, a semi-permanent government deficit, needs to be further investigated, especially in its implication for EMU macroeconomic governance

There are a number of ways, not necessarily politically feasible, to allow EMU countries to run semi-permanent government deficits. A first one could be to restore complete national budget sovereignty, (scrapping the Stability Pact). This would mean relying on market discipline alone for maintaining fiscal responsibility. As an alternative, at the opposite side of the spectrum, countries could create a federal expenditure capacity (which would imply the creation of an EMU finance minister with capacity to spend, the issuance of Eurobonds, etc.). Such an option is as unrealistic as the previous one. In an ideal world, the crisis and deflation would be dealt with by means of a vast European investment program, financed by the European budget and through Eurobonds. Infrastructures, green growth, the digital economy, are just some of the areas for which the optimal scale of investment is European, and for which a long-term coordinated plan would necessary. The increasing mistrust among European countries exhausted by the crisis, and the fierce opposition of Germany and other northern countries to any hypothesis of debt mutualisation, make this strategy virtually impossible. The solution must therefore be found at national level, without giving up European-wide coordination, which would guarantee effective and fiscally sustainable investment programs.

In general, the multiplier associated with public investment is larger than the overall expenditure multiplier. This is particularly true in times of crisis, when the economy is, like today, at the zero lower bound. With Kemal Dervis I proposed that the EMU adopts a fiscal rule similar to the one implemented in the UK by Chancellor of the Exchequer Gordon Brown in the 1990s, and applied until 2009. The new rule would require countries to balance their current budget, while financing public capital accumulation with debt. Investment expenditure, in other words, would be excluded from deficit calculation, a principle that timidly emerges also in the Juncker plan. Such a rule would stabilize the ratio of debt to GDP, it would focus efforts of public consolidation on less productive items of public spending, and would ensure intergenerational equity (future generations would be called to partially finance the stock of public capital bequeathed to them). Last, but not least, especially in the current situation, putting in place such a rule would not require treaty changes, and it is already discussed, albeit timidly, in EU policy circles.

To avoid the bias towards capital expenditure that the golden rule could trigger, we proposed that at regular intervals, for example in connection with the European budget negotiation, the Commission, the Council and the Parliament could find an agreement on the future priorities of the Union, and make a list of areas or expenditure items exempted from deficit calculation for the subsequent years.

John Maynard Trump?

November 10, 2016 3 comments

A sentence from Donald Trump’s victory speech retained a good deal of attention:

We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals. We’re going to rebuild our infrastructure, which will become, by the way, second to none. And we will put millions of our people to work as we rebuild it.

This was widely quoted in the social media, together with the following from an FT article about the Fed:

In particular, some members of his economic advisory team are convinced that central banks such as the US Federal Reserve have exhausted their use of super-loose monetary policy. Instead, in the coming months they hope to announce a wave of measures such as infrastructure spending, tax reform and deregulation to boost growth — and combat years of economic stagnation.

In spite of its vagueness, the idea of an infrastructure push has sent markets to beyond the roof. In short, a simple (and rather generic) speech on election night has dispelled all the anxiety about the long phase of uncertainty that we face. So long for efficient markets…

But this is not what I care about here. The point I want to make is that Trump’s announcement has triggered a strange reaction. Something going like: “See? Trump managed to break the establishment’s hostility to Keynes and to finally implement the stimulus policies we need. Forget the sexism and the p-word, the attacks on minorities, the incompetence. Enter Trump, exit neo-liberalism”. I see this especially (but not only) among Italian internauts, who tend to project the European situation in other contexts.

Well, I have some reservations on this claim. Where to start? Maybe with the “Contract with the American Voter“, that together with the (generic, once more) promise of new investment, promised a massive withdrawal of the State from the economy? Or from the fact that “Establishment Obama” made Congress vote, a month into his presidency, a “Recovery Act (ARRA)” worth 7% of GDP, that successfully stopped the free-fall and helped restore growth? Or from the fact that the “anti-establishment” Tea Party forced austerity since 2011, climaxing in the sequester saga of 2013?

Critics of current austerity policies in Europe should not be delusional. Trump is not the John Maynard Keynes of 2016. His agenda is, broadly speaking, an agenda of deregulation, tax cuts for the rich, and retreat of the State from the economy. Not to mention the strong chance of a more hawkish Fed in the future. To sum up, Trump is, in the best case scenario a new Reagan, substituting military Keynesianism with bridges’ Keynesianism. And we all (should) know that Reaganomics does shine much less than usually claimed.

Those progressives looking for a Trump Keynesian agenda should probably have looked more carefully at the plan proposed by “establishment-Clinton”: A significant infrastructure push (in fact, the emphasis on infrastructures was the only point in common between the two candidates), with the ambition to crowd-in private investment. And what is more important, such an expansionary fiscal policy was framed within a more active role of the government in key sectors like education, health care, and with increased progressivity of the tax system.

Would we have had Hilary Rodham Keynes? Unfortunately we’ll never know…

Monetary Policy: Credibility 2.0

October 24, 2016 3 comments

Life and work keep having the nasty habit of intruding into this blog, but it feels nice to resume writing, even if just with a short comment.

We learned  a few weeks ago that the Bank of Japan has walked one extra step in its attempt to escape lowflation, and that it has committed to overshoot its 2% inflation target.  A “credible promise to be irresponsible”,  as the FT says quoting Paul Krugman.

This may be a long overdue first step towards a revision of the inflation target, as invoked long ago by Olivier Blanchard, and more recently by Larry Ball. This is all too reasonable: if the equilibrium interest rates are negative, if monetary policy is bound by the zero-or-only-slightly-negative-lower-bound, higher inflation targets would make sense, and 4% is an arbitrary target as legitimate as the current also arbitrary 2% level. Things may be moving, as the subject was evoked, if not discussed, at the recent Central Bankers gathering in Jackson Hole. We’ll see if anything comes out of this.

But the FT also adds an interesting comment to the BoJ move, namely that the more serious risk is a blow to credibility. If it failed to lift the inflation to the 2% target, how can it be credibly believed to overshoot it?

This is a different sort of credibility issue, much more reasonable indeed, than the one we have been used to in the past three decades, linked to the concept of dynamic inconsistency. In plain English the idea that an actor has no incentive to keep prior commitments that go against its own interest, and hence deviates from the initial plan. Credibility was therefore associated to changing incentives over time (typically for policy makers), and invoked to recommend rules over discretion.

Today, eight years into the zero lower bound, we go back to a more intuitive definition of credibility: announcing an objective and not being able to attain it.

The difference between the two definitions of credibility is not anodyne. In the first case, the unwillingness of central banks to behave appropriately can be corrected through the adoption of constraining rules. In the latter, the central bank cannot attain the objective regardless of incentives and constraints, and other strategies need to be put in place.

The other strategy, the reader will not be surprised to learn, is fiscal policy. Monetary dominance is in fact a second tenet of the Consensus from the 1990s that the crisis has wiped out. We used to live in a world in which structural reforms would take care of increasing potential growth, monetary policy would be used to take care of (minor) demand-driven fluctuations, and fiscal policy was in a closet.

This is gone (luckily). Even the large policy making institutions now call for a comprehensive and multi-instrument policy making. The policy mix, a central element of macroeconomics in the pre-rational expectations era, is now back.  Even the granitic dichotomy between short (demand driven) and long (supply driven) term, is somewhat rediscussed.

The excessively simplified consensus that dominated macroeconomics for the past thirty years seems to be seriously in trouble; complexity, tradeoffs, coordination, are now the issues discussed in academia and in policy circles. This is good news.

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