Posts Tagged ‘austerity’

Draghi the Fiscal Hawk

October 23, 2015 4 comments

We are becoming accustomed to European policy makers’ schizophrenia, so when yesterday during his press conference Mario Draghi mentioned the consolidating recovery while announcing further easing in December, nobody winced. Draghi’s call for expansionary fiscal policies was instead noticed, and appreciated. I suggest some caution. Let’s look at Draghi’s words:

Fiscal policies should support the economic recovery, while remaining in compliance with the EU’s fiscal rules. Full and consistent implementation of the Stability and Growth Pact is crucial for confidence in our fiscal framework. At the same time, all countries should strive for a growth-friendly composition of fiscal policies.

During the Q&A, the first question was on precisely this point:

Question: If I could ask you to develop the last point that you made. Governor Nowotny last week said that monetary policy may be coming up to its limits and perhaps it was up to fiscal policy to loosen a little bit to provide a bit of accommodation. Could you share your thoughts on this and perhaps even touch on the Italian budget?

(Here is the link to  Austrian Central Bank Governor Nowotny making a strong statement in favour of expansionary fiscal policy). Draghi simply did not answer on fiscal policy (nor on the Italian budget, by the way). The quote is long but worth reading

Draghi: On the first issue, I’m really commenting only on monetary policy, and as we said in the last part of the introductory statement, monetary policy shouldn’t be the only game in town, but this can be viewed in a variety of ways, one of which is the way in which our colleague actually explored in examining the situation, but there are other ways. Like, for example, as we’ve said several times, the structural reforms are essential. Monetary policy is focused on maintaining price stability over the medium term, and its accommodative monetary stance supports economic activity. However, in order to reap the full benefits of our monetary policy measures, other policy areas must contribute decisively. So here we stress the high structural unemployment and the low potential output growth in the euro area as the main situations which we have to address. The ongoing cyclical recovery should be supported by effective structural policies. But there may be other points of view on this. The point is that monetary policy can support and is actually supporting a cyclical economic recovery. We have to address also the structural components of this recovery, so that we can actually move from a cyclical recovery to a structural recovery. Let’s not forget that even before the financial crisis, unemployment has been traditionally very high in the euro area and many of the structural weaknesses have been there before.

Carefully avoiding to mention fiscal policy, when answering a question on fiscal policy, speaks for itself. In fact, saying that “Fiscal policies should support the economic recovery, while remaining in compliance with the EU’s fiscal rules” and putting forward for the n-th time the confidence fairy, amounts to a substantial approval of the policies followed by EMU countries so far. We should stop fooling ourselves: Within the existing rules there is no margin for a meaningful fiscal expansion of the kind invoked by Governor Nowotny. If we look at headline deficit, forecast to be at 2% in 2015, the Maastricht limits leave room for a global fiscal expansion of 1% of GDP, decent but not a game changer (without mentioning the fiscal space of individual countries, very unevenly distributed). And if we look at the main indicator of fiscal effort put forward by the fiscal compact, the cyclical adjusted deficit, the eurozone as a whole should keep its fiscal consolidation effort going, to bring the deficit down from its current level of 0.9% of GDP to the target of 0.5%.

It is no surprise then that the new Italian budget (on which Mario Draghi carefully avoided to comment) is hailed (or decried) as expansionary simply because it slows a little (and just a little) the pace of fiscal consolidation. Within the rules forcefully defended by Draghi, this is the best countries can do. As a side note, I blame the Italian (and the French) government for deciding to play within the existing framework. Bargaining a decimal of deficit here and there will not lift our economies out of their disappointing growth; and more importantly, on a longer term perspective, it will not help advance the debate on the appropriate governance of the eurozone.

In spite of widespread recognition that aggregate demand is too low, Mario Draghi did not move an inch from his previous beliefs: the key for growth is structural reforms, and structural reforms alone. He keeps embracing the Berlin View. The only substantial difference between Draghi and ECB hawks is his belief that, in the current cyclical position, structural reforms should be eased by accommodating monetary policy. This is the only rationale for QE. Is this enough to define him a dove?

EMU Troubles: The Narrow Way Out

September 18, 2015 4 comments

I was asked to write a piece on whether we should continue to study the EMU (my answer is yes. In case you wonder, this is called vested interest). One section of it can be a stand-alone blog post: Here it is, with just a few edits:

While in the late 1980s the consensus among economists and policy makers was that the EMU was not an optimal currency area (De Grauwe, 2006), the choice was made to proceed with the single currency for two essentially opposed reasons: The first, stemming from the Berlin-Brussels Consensus, saw monetary integration, together with the establishment of institutions limiting fiscal and monetary policy activism, as an incentive for pursuing structural reforms and converging towards market efficiency: as the role of macroeconomic management was believed to be limited, giving up monetary policy would impose negligible costs to countries while forcing them, through competition, to remove growth-stifling  obstacles to markets.

Another group of academics and policy makers, while not necessarily subscribing to the Consensus, highlighted the political economy of the single currency: Adopting the euro in a non-optimal currency area would have created the incentives for completing it with a political union: a federation, endowed with a common fiscal policy and capable of implementing the fiscal transfers that are required to avoid divergence. In other words a non-optimal euro was seen as just an intermediate step towards a real United States of Europe. A key argument of the proponents of a federal Europe was, and still is, that fiscal transfers seem unavoidable to ensure economic convergence. A seminal paper by Sala-i-Martin and Sachs (1991) shows that even in the United States, where market flexibility is substantially larger than in the EMU, transfers from booming states to states in crisis account for almost 50% of the reaction to asymmetric shocks.

It is interesting to notice how the hopes of both views were dashed by subsequent events. As the theory of optimal currency areas correctly predicted, the inception of the euro without sufficiently strong correction mechanisms, triggered a divergence between a core, characterized by excess savings and export-led growth, and a periphery that sustained the Eurozone growth through debt-driven (public and private) consumption and investment.

Even before the crisis the federal project failed to make it into the political agenda. The euro came to be seen by the political elites not, as the federalists hoped, as an intermediate step towards closer integration, but rather as the endpoint of the process initiated by Jean Monnet and Robert Schuman in 1950. The crisis further deepened economic divergence and recrimination, highlighting national self-interest as the driving force of policy makers, and making solidarity an empty word. As we write, the Greek crisis management, the refugee emergency, the centrifugal forces shaking Europe, are seen as a potential threat to the Union, rather than a push for further integration as it happened in the past (Rachman, 2015).

The Consensus partisans won the policy debate. The EMU institutions, banning discretionary policy, reflect their intellectual framework; and the policies followed (more or less willingly) by EMU countries, especially since the crisis, are the logical consequences of the consensus: austerity and structural reforms aimed at increasing competitiveness and reducing the weight of the State in the economy. But while they can rejoice of their victory, Consensus proponents have to deal with the failure of their policies: five years of Berlin View therapy has nearly killed the patient. Peripheral countries’ debt is still unsustainable, growth is nowhere to be seen (including in successful Germany), and social hardship is reaching unbearable levels (Kentikelenis et al., 2014). Coupling austerity with reforms proved to be self-defeating, as the short term recessionary impact on the economy was much larger than expected (Blanchard and Leigh, 2013), and as a consequence the long run benefits failed to materialize (Eggertsson et al., 2014). It is then no surprise that in spite of austerity and reforms, divergence between the core and the periphery of the Eurozone is even larger today than it was in 2007.

The dire state of the Eurozone economy is in some sense the revenge of optimal currency areas theory, with a twist. It appears evident today, but it was clear two decades ago, that market flexibility alone would never suffice to ensure convergence (rather the opposite), so that the Consensus faces a potentially fatal challenge. On the other hand, the federalist project, that was already faltering, seems to have received a fatal blow from the crisis.

The conclusion I draw from these somewhat trivial considerations is that the EMU is walking a fine line. If the federalist project is dead, and if Consensus policies are killing the EMU, what have we left, besides a dissolution of the euro?

I conclude the paper by arguing that two pillars of a new EMU governance/policy are necessary (neither of them in isolation would suffice):

  1. Putting in place any possible surrogate of fiscal transfers, like for example a EU wide unemployment benefit, making sure that it is designed to be politically feasible (i.e. no country is net contributor on average), eurobonds, etc.
  2. Scrapping  the Consensus together with its foundation, the efficient market hypothesis, and head towards real, flexible coordination of (imperfect) macroeconomic policies in order to deal with (imperfect) markets. Government by the rules only works in the ideal neoclassical world.

I know, more easily said than done. But I see no other possibility.

And the Winner is (should be)…. Fiscal Policy!

September 4, 2015 2 comments

So, Mario Draghi is disappointed by eurozone growth, and is ready to step up the ECB quantitative easing program. The monetary expansion apparently is not working out as planned.

Big surprise. I am afraid some people do not have access to Wikipedia. If they had, they would read, under “liquidity trap“, the following:

A liquidity trap is a situation, described in Keynesian economics, in which injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

In a liquidity trap the propensity to hoard of the private sector becomes virtually unlimited, so that monetary policy (be it conventional or unconventional) loses traction. It is true that the age of great moderation, and three decades of almighty central bankers had made the concept fade into oblivion. But, since 2008 we were forced to reconsider the effectiveness of monetary policy at the so-called zero lower bound.Or at least we should have…

So, had policy makers taken the time to look at the history of the great depression, or at least to open the Wikipedia entry, they should have learnt that when monetary policy loses traction, the witness in lifting the economy out of the recession, needs to be taken by fiscal policy. In a liquidity trap the winner is fiscal policy.  Or at least it should be. Here is a measure of the fiscal stance, computed as the change in government balance once we exclude cyclical components and interest payments.

2015_09_LiquidityThe vast majority of EMU countries undertook a strong fiscal tightening, regardless of the actual health of their public finances. This generalized austerity, an offspring of the Berlin View, led to our double dip recession, and to further divergence in the eurozone, that would have needed coordinated, not synchronized fiscal policies. Well done guys…

And yet, Mario Draghi is surprised by the impact of QE.

Convergence, Where Art Thou?

September 2, 2015 2 comments

A new Occasional Paper details the new methodology adopted by the Bank of Italy for calculating an index of price competitiveness, and applies it to the four largest eurozone economies.

I took the time to copy the numbers of table 3 in an excel file (let’s hope for the best), and to look at what happened since 2009. Here is the evolution of price competitiveness (a decrease means improved competitiveness):


I find this intriguing. We have been sold the story of Spain as the success story for EMU austerity as, contrary to other countries, it restored its external balance through internal devaluation. Well, apparently not. Since 2008 its price competitiveness improved, but less so than in the three other major EMU countries.

The reason must be that the rebalancing was internal to the eurozone, so that the figure does not in fact go against austerity nor internal devaluation. For sure, within eurozone price competitiveness improved for Spain. Well, think again…


This is indeed puzzling, and goes against anedoctical evidence. We’ll have to wait for the new methodology to be scrutinized by other researchers before making too much of this. But as it stands, it tells a different story from what we read all over the places. Spain’s current account improvement can hardly be related to an improvement in its price competitiveness. Likewise, by looking at France’s evolution, it is hard to argue that its current account problems are determined by price dynamics.

Without wanting to draw too much from a couple of time series, I would say that reforms in crisis countries should focus on boosting non-price competitiveness, rather than on reducing costs (in particular labour costs). And the thing is, some of these reforms may actually need increased public spending, for example in infrastructures, or in enhancing public administration’s efficiency. To accompany these reforms there is more to macroeconomic policy than just reducing taxes and at the same time cutting expenditure.

Since 2010 it ha been taken for granted that reforms and austerity should go hand in hand. This is one of the reasons for the policy disaster we lived. We really need to better understand the relationship between supply side policies and macroeconomic management. I see little or no debate on this, and I find it worrisome.

Are we Sure that Tsipras Caved In?

July 11, 2015 4 comments

Germany did not speak yet, and until then nothing is certain. But it looks like the new Tsipras proposal may turn into an agreement between Greece and its creditors.

We’ll see what happens in the next days, but I want to make a few remarks

At first sight, this does not look good for Tsipras. On all the points that remained contentious when negotiations were interrupted, the new proposal substantially accepts the creditors requests (labour law being an important exception): On VAT, privatizations, retirement age, we are now very close to the original creditors’ requests, and very far from the Greek ones.

And in fact the new package is even more “austerian” than the Juncker plan, as it contains deficit reduction for 12 billions instead of 8.

This said, if Tsipras manages to link the package to the obtention of a new loan (plus unblocking of structural funds) for a duration of three years, he will have obtained what he has been asking so far in vain, and what had been refused to Papandreou in 2011: Time and money.

While accusing him of doing nothing to change his country, creditors forced Tsipras to spend the past five months flying back and forth from Athens to Brussels, each time asking for a fistful of euros. If he manages to obtain a new loan over the next three years, this will finally stop. He will have the time to implement his recipe for Greece, and it will be finally possible to judge his government on acts rather than promises.

In this light the referendum was very important. By asking the Greek people the mandate to negotiate while remaining in the euro, he succeeded in throwing the ball in the creditors camp. Those speaking of betrayal of the people’s will probably did not pay attention to the Greek debate in the week of July 5th. This is why Syriza keeps climbing in the polls, by the way.

Tsipras had to pay the price of a stricter austerity than he would have wished for. But he gains breathing space, which is orders of magnitude more valuable. No surprise that Germany is hesitant. If a deal is not reached, as of now, it will be clear to all who will have kicked Greece out.

Not a bad day for Tsipras after all

Of Democracy and of a Different Europe

July 6, 2015 3 comments

I have mixed feeling about the Oki victory in Greece. The choice was between two evils: slow death by more of the same (the troika plan), or a roller-coaster ride that has a high chance of ending catastrophically for Greece and for the EMU. I would have voted no, were I Greek, but not joyfully. This said, two things I have been reading in the past days are disturbing:

  1. First, the claim that Tsipras’ rhetoric on democracy is misplaced: After all, people say, we all are democracies. Why should Greek democracy count more than the Portuguese, or the Spanish one? There is no reason, of course. Point is that Tsipras did something that is now really revolutionary in Europe, he tried – hold your breath –  to implement the platform on which he was elected. How many governments in Europe went to power promising an end to austerity, promising a “new deal for Europe”, just to retract a few months/weeks/days later and align themselves with the Berlin View that austerity is the only way? Greek democracy today should count more than democracy in the rest of Europe, because it is the only case in which voters are actually listened to by their government. This is why Syriza’s anomaly needed to be crushed, well beyond the actual content of its proposed policies. If European policy makers feel that their democracy should be as important as Greece’s, they could start by trying to do what their voters elected them for. That would certainly not hurt.
  2. The second thing that bothers me, is the convergence of the establishment and of euro-skeptical movements across Europe. Don’t be fooled by the enthusiastic adherence of many no-euro movements to the Oki campaign Their siding with Tsipras was instrumental to Grexit, turmoil, and weakening the euro itself. Something orthogonal to what Tsipras has been doing and saying in the past two years. The referendum made it clear that the establishment and the no-euro converge in trying to prove that there is no alternative to austerity in Europe. The former, because if Greece is not normalized, we would enter into a new phase in which statements and policies would have to be assessed on the basis of facts (not so favorable to austerity) rather than taken as a matter of faith. Euro skeptics need Tsipras to be crushed because this would definitely prove that the only way to get rid of austerity is to get rid of the euro altogether.

Therefore the referendum, while certainly hazardous and ill-conceived (what did the Greek people vote on, in the end?), had the great merit of exposing the hypocrisy of some commentators, and to show that the only hope for a different Europe has to be found in the struggle that an inexperienced prime minister is leading from Athens. Since yesterday, with the renewed support of his people. Dangerous times ahead, but with a small hope for change.