Posts Tagged ‘growth’

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.

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%.


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)

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?


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.


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.

Trump and Reagan

January 28, 2017 1 comment

A couple of days ago I had an interesting debate hosted by France 24, on Trumponomics. Interesting because there was an overall agreement between me and Dan Mitchell from Cato Institute, even if from totally opposite points of view, on the fact that Trumponomics does not exist. The Donald is pushing forward a number of inconsistent measures, whose final effect is impossible to forecast (except that it is a safe bet to say that it will not end well).

Mitchell argued of course that the only good policies imply the downsizing of the government. As one can easily imagine I would tend to disagree. And over and over again, during the 40 or so minutes of discussion, came back the reference to the golden era of Ronald Reagan. Trump needs to cut taxes, as Reagan did, and downsize government, as Reagan did. And growth and unemployment will return, as under Reagan

When I said that the problem of the US was not the lack of jobs per se, but rather the increasingly unequal distribution of income, that started precisely under Reagan, Mitchell replied that this was false (I officially spread fake truths!), claiming that median income under Reagan increased. Well, think again. An old post by Paul Krugman had already dispelled the mith, and I had written on it myself. I copy the figure from that post (updated) here:



So, while it is true that median income increased under Reagan-Bush (Mitchell is formally right), it is hard to define it an era or decreasing inequality I My conclusion back then was that growth does not lift all boats, and trickle-down economics does not exist. And Reagan did not do that well in terms of growth either. And did I mention twin deficits?

Just a final remark. The downsizing of government under Reagan is also a myth (which is rather good news, by the way): Look at OECD data:2017_01_trump_and_reagan


I rest my case. People at Cato should pick their role models more carefully.



What Went Wrong with Jean-Baptiste

December 2, 2016 2 comments

The news of the day is that François Hollande will not seek reelection in May 2017. This is rather big news, even it if was all too logical given his approval ratings. But what went wrong with Hollande’s (almost) five years as a President?

Well, I believe that the answer is in a post I wrote back in 2014, Jean-Baptiste Hollande. There I wrote that the sharp turn towards supply side measures (coupled with austerity) to boost growth was doomed to failure, and that firms themselves showed, survey after survey, that the obstacles they faced  came from insufficient demand and not from the renown French “rigidities” or from the tax burden. I was not alone, of course in calling this a huge mistake. Many others made the same point. Boosting supply during an aggregate demand crisis is useless, it is as simple as that. Allow me to quote the end of my post:

Does this mean that all is well in France? Of course not. The burden on French firms, and in particular the tax wedge, is a problem for their competitiveness. Finding ways to reduce it, in principle is a good thing. The problem is the sequencing and the priorities. French firms seem to agree with me that the top priority today is to restart demand, and that doing this “will create its own supply”. Otherwise, more competitive French firms in a context of stagnating aggregate demand will only be able to export. An adoption of the German model ten years late. I already said a few times that sequencing in reforms is almost as important as the type of reforms implemented.

I am sure Hollande could do better than this…

It turns out that we were right. A Policy Brief (in French) published by OFCE last September puts all the numbers together (look at table 1): Hollande did implement what he promised, and gave French firms around €20bn (around 1% of French GDP) in tax breaks. These were compensated, more than compensated actually, by the increase of the tax  burden on households (€35bn). And as this tax increase assorted of reshuffling was not accompanied by government expenditure, it logically led to a decrease of the deficit (still too slow according to the Commission; ça va sans dire!). But, my colleagues show, this also led to a shortfall of demand and of growth. A rather important one. They estimate the negative impact of public finances on growth to be almost a point of GDP per year since 2012.

Is this really surprising? Supply side measures accompanied by demand compression, in a context of already insufficient demand, led to sluggish growth and stagnating employment (it is the short side of the market baby!). And to a 4% approval rate for Jean-Baptiste Hollande.

OFCE happens to have published, just yesterday, a report on public investment in which we of join the herd of those pleading for increased public investment in Europe, and in particular in France. Among other things, we estimate that a public investment push of 1% of GDP, would have a positive impact on French growth and would create around 200,000 jobs (it is long and it is in French, so let me help you: go look at page 72).  Had it been done in 2014 (or earlier) instead of putting the scarce resources available in tax reductions, things would be very different today, and probably M. Hollande yesterday would have announced his bid for a second mandate.

In a sentence we don’t need to look too far, to understand what went wrong.

Two more remarks: first, we have now mounting evidence of what we could already expect in 2009 based on common sense. Potential growth is not independent of current economic conditions. Past and current failure to aggressively tackle the shortage of demand that has been plaguing the French – and European – economy, hampers its capacity to grow in the long run. The mismanagement of the crisis is condemning us to a state of semi-permanent sluggish growth, that will keep breeding demagogues of all sorts. The European elites do not seem to have fully grasped the danger.

Second, France is not the only large eurozone country that has taken the path of supply side measures to pull the economy out of a demand-driven slump. The failure of the Italian Jobs Act in restarting employment growth and investment can be traced to the very same bad diagnosis that led to Hollande’s failure. Hollande will be gone. Are those who stay, and those who will follow, going to change course?

A Piketty Moment

October 25, 2016 6 comments

Update (10/27): Comments rightly pointed to different deflators for the two series. I added a figure to account for this (thanks!)

Via Mark Thoma I read an interesting Atalanta Fed Comment about their wage tracker, asking whether the recent pickup of wages in the US is robust or not.

The first thing that came to my mind is that we’d need a robust and sustained increase, in order to make up for lost ground, so I looked for longer time series in Fred, and here is what I got


This yet another (and hardly original) proof of the regime change that occurred in the 1970s, well documented by Piketty. Before then, US productivity (output per hour) and compensation per hour  roughly grew together. Since the 1970s, the picture is brutally different, and widely discussed by people who are orders of magnitude more competent than me.

[Part added 10/27: Following comments to the original post, I added real compensation defled with the GDP deflator.  While this does not account for purchasing power changes, it is more directly comparable with real output. Here is the result:


The commentators were right, the divergence starts somewhat later, in the early 1980s. This makes it less of a Piketty moment, while leaving the broad picture unchanged.]

Next, I tried to ask whether it is better for wage earners, in this generally gloomy picture, to be in a recession or in a boom. I computed the difference between productivity (output per hour) and wages (compensation per hour), and averaged it for NBER recession and expansion periods (subperiods are totally arbitrary. i wanted the last boom and bust to be in a single row). Here is the table:

Yearly Average Difference Between Changes in Productivity and in Wages
In Recessions In Expansions Overall % of Quarters in Recession
1947-2016 1.51% 0.40% 0.57% 15%
1947-1970 1.62% -0.14% 0.19% 19%
1970-2016 1.42% 0.67% 0.76% 13%
1980-1992 0.64% 0.84% 0.81% 17%
1993-2000 N/A 0.68% 0.68% 0%
2001-2008Q1 4.07% 1.10% 1.41% 10%
2008Q2-2016Q2 2.17% 0.12% 0.49% 18%
Source: Fred (my calculations)
Compensation: Nonfarm Business Sector, Real Compensation Per Hour
Productivity: Nonfarm Business Sector, Real Output Per Hour

No surprise, once again, and nothing that was not said before. The economy grows, wage earners gain less than others; the economy slumps, wage earners lose more than others.  As I said a while ago, regardless of the weather stones keep raining. And it rained particularly hard in the 2000s. No surprise that inequality became an issue at the outset of the crisis…

There is nevertheless a difference between recessions and expansions, as the spread with productivity growth seems larger in the former. So in some sense, the tide lifts all boats. It is just that some are lifted more than others.

Ah, of course Real Compensation Per Hour embeds all wages, including bonuses and stuff. Here is a comparison between median wage,compensation per hour, and productivity, going as far back as data allow.


I don’t think this needs any comment.


April 29, 2016 13 comments

Stronger than expected GDP growth in France and Spain (0.5% and 0.8% in 2016Q1, 0.1% more than expected!) has boosted Eurozone GDP to a staggering +0.6% in the first quarter of 2016. The Financial Times notes that GDP is now above its pre-crisis level. I expect, in the next few days, celebrations in some quarters.

So, just a reminder:

The figure speaks for itself. While we had a lost decade (eight-ade), The US and the OECD as a whole were out of the woods in 2011Q2. Our neighbours across the Channel in 2013Q2. Furthermore, we were the only ones to go through a double dip recession, and are the only ones still fighting with deflationary pressures.

Of course, if we look at per capita GDP (warning, I constructed it myself, simply dividing real GDP by population on January 1st), the lost decade may materialize after all:
I added Greece as a second reminder. The country is back at case one, in yet another round of difficult negotiations. And I do believe that remembering what they have endured may help

So, tell me again, what should we be celebrating?

Commission Forecasts Watch – November 2014 Edition

November 4, 2014 2 comments

Update (11/10): Well, I typed a few numbers wrong,  for France and Finland (thanks to Tadej Kotnik for pointing this out). I corrected the data, and stroke down the remarks on Finland that with the corrected data does not beat the expectations. Apologies to the readers

Today the Commission issued its Autumn forecast. It is therefore time to update my forecast watch. Here it is:


Last March, my crystal ball gave me a forecasted growth  of 0.55% for the EMU, while the Commission forecasted 1.2% (In March it was 1.1% but it had then been revised in May). As of today (if things do not get worse, in which case I will be even closer), my forecast error is -0.25%, and the Commission’s is +0.4% I win, the Commission loses.

After 2013, when they were remarkably close, Commission forecasts seem to have diverged once more, at least last Spring. We’ll have to see what the final figure for 2014 is (My crystal ball forecast update gives 0.65%).

But besides playing with numbers, the interesting thing about this year’s Autumn forecasts, is that growth has been revised downwards especially for core countries.


In particular since last Spring the mood has changed about Germany, whose growth forecast has been slashed of 0.5% for 2014 (in just a few months, it is worth reminding it), and of 0.9% (almost halved) for 2015. Also interestingly, the only core country whose expectations have been revised upwards, Finland, is also the only one that got rid of its excess savings and current account surplus.

We all know that the disappointing performance of Germany is due, mostly, to geopolitical uncertainty and low growth in emerging economies. When will our German friends understand that putting all eggs in the basket of foreign demand is risky?

Smoke Screens

October 14, 2014 13 comments

I have just read Mario Draghi’s opening remarks at the Brookings Institution. Nothing very new with respect to Jackson Hole and his audition at the European Parliament. But one sentence deserves commenting; when discussing how to use fiscal policy, Draghi says that:

Especially for those [countries] without fiscal space, fiscal policy can still support demand by altering the composition of the budget – in particular by simultaneously cutting distortionary taxes and unproductive expenditure.

So, “restoring fiscal policy” should happen, at least in countries in trouble, through a simultaneous reduction of taxes and expenditure. Well, that sounds reasonable. So reasonable that it is exactly the strategy chosen by the French government since the famous Jean-Baptiste Hollande press conference, last January.

Oh, wait. What was that story of balanced budgets and multipliers? I am sure Mario Draghi remembers it from Economics 101. Every euro of expenditure cuts, put in the pockets of consumers and firms, will not be entirely spent, but partially saved. This means that the short term impact on aggregate demand of a balanced budget expenditure reduction is negative. Just to put it differently, we are told that the risk of deflation is real, that fiscal policy should be used, but that this would have to happen in a contractionary way. Am I the only one to see a problem here?

But Mario Draghi is a fine economist, many will say; and his careful use of adjectives makes the balanced budget multiplier irrelevant. He talks about distortionary taxes. Who would be so foolish as not to want to remove distortions? And he talks about unproductive expenditure. Again, who is the criminal mind who does not want to cut useless expenditure? Well, the problem is that, no matter how smart the expenditure reduction is, it will remain a reduction. Similarly, even the smartest tax reduction will most likely not be entirely spent; especially at a time when firms’ and households’ uncertainty about the future is at an all-times high. So, carefully choosing the adjectives may hide, but not eliminate, the substance of the matter: A tax cut financed with a reduction in public spending is recessionary, at least in the short run.

To be fair there may be a case in which a balanced budget contraction may turn out to be expansionary. Suppose that when the government makes one step backwards, this triggers a sudden burst of optimism so that private spending rushes to fill the gap. It is the confidence fairy in all of  its splendor. But then, Mario Draghi (and many others, unfortunately) should explain why it should work now, after having been invoked in vain for seven years.

Truth is that behind the smoke screen of Draghinomics and of its supposed comprehensive approach we are left with the same old supply side reforms that did not lift the eurozone out of its dire situation. It’ s the narrative, stupid!


Walls Come Tumbling Down

August 16, 2014 9 comments

Yesterday I quickly commented the disappointing growth data for Germany and for the EMU as a whole, whose GDP Eurostat splendidly defines “stable”. This is bad, because the recovery is not one, and because we are increasingly dependent on the rest of the world for that growth that we should be able to generate domestically.

Having said that, the real bad news did not come from Eurostat, but from the August 2014 issue of the ECB monthly bulletin, published on Wednesday. Thanks to Ambrose Evans-Pritchard I noticed the following chart ( page 53):

The interesting part of the chart is the blue dotted line, showing that the forecasters’ consensus on longer term inflation sees more than a ten points drop of the probability that inflation will stay at 2% or above. Ten points in just a year. And yet, just a few pages above we can read:

According to Eurostat’s flash estimate, euro area annual HICP inflation was 0.4% in July 2014, after 0.5% in June. This reflects primarily lower energy price inflation, while the annual rates of change of the other main components of the HICP remained broadly unchanged. On the basis of current information, annual HICP inflation is expected to remain at low levels over the coming months, before increasing gradually during 2015 and 2016. Meanwhile, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with the aim of maintaining inflation rates below, but close to, 2% (p. 42, emphasis added) 

The ECB is hiding its head in the sand, but expectations, the last bastion against deflation, are obviously not firmly anchored. This can only mean that private expenditure will keep tumbling down in the next quarters. It would be foolish to hope otherwise.

So we are left with good old macroeconomic policy. I did not change my mind since my latest piece on the ECB. Even if the ECB inertia is appalling, even if their stubbornness in claiming that everything is fine (see above) is more than annoying, even if announcing mild QE measures in 2015 at  the earliest is borderline criminal, it remains that I have no big faith in the capacity of monetary policy to trigger decent growth.  The latest issue of the ECB bulletin also reports the results of the latest Eurozone Bank Lending Survey. They show a slow easing of credit conditions, that proceed in parallel with a pickup of credit demand from firms and households. While for some countries credit constraints may play a role in keeping private expenditure down (for example, in Italy), the overall picture for the EMU is of demand and supply proceeding in parallel. Lifting constraints to lending, in this situation, does not seem likely to boost credit and spending. It’s the liquidity trap, stupid!

The solution seems to be one, and only one: expansionary fiscal policy, meaning strong increase in government expenditure (above all for investment) in countries that can afford it (Germany, to begin with); and delayed consolidation for countries with struggling public finances. Monetary policy should accompany this fiscal boost with the commitment to maintain an expansionary stance until inflation has overshot the 2% target.

For the moment this remains a mid-summer dream…