From Eurotimidity to Euroaudacity
A new proposal has come from a group of leading European economists (the Resiliency Authors) on how to shore up the Eurozone’s resiliency. Their recipe includes diversifying bank portfolios; decreasing banks’ overexposure to domestic loans; transferring the responsibility for banks’ rescue from national governments to the European Stability Mechanism (although the authors consider this option to be politically unfeasible); introducing fiscal expenditure rules (linking expenditure reduction to debt levels); strengthening the ESM, and making it more effective and better coordinated with the ECB; and further adjusting competitiveness with more structural reforms.
Would these measures improve the Eurozone resilience to future bad shocks?
Yet, is resilience the very first priority for the Eurozone at this point in time? Is it really what the Eurozone needs now?
Not so, according to Professors Paul Krugman and Brad DeLong and. “Europe is a depressed economy with inflation well below a reasonable target – say Krugman– desperately in need of more demand, with this aggregate problem exacerbated by the problems of adjustment within a single currency. And here we have a manifesto calling for smaller government and structural reform”.
Krugman’s comments echo DeLong’s, who in his 11-point comment to the proposal asserts that, “A depressed economy at the zero lower bound needs fiscal expansion. If for some reason normal fiscal expansion is feared to be unwise by some holding veto points, the economy needs helicopter drops”.
These views sound very right to us: depressed demand is the single most important and urgent problem the Eurozone faces today and for years to come. While the measures recommended by the Resiliency Authors might improve on some of the current structural weaknesses of the area, they would hardly do much to impress a drastic change upon the factors that motivate increasing people’s disaffection with the “European dream”.
Only an audacious, real boost to demand, output and employment would trigger new hopes and subvert the pessimistic expectations that hold the economy in a trap. And only a rapid change in Eurozone growth would genuinely improve its resilience, reducing its debt and decreasing its exposure to risks. Structural reforms? Fine, but they would work (and people would accept more of them) only in an environment of sustained demand.
But how can demand be kick started?
Helicoptering “fiscal money”
Fiscal space is heavily constrained in the Eurozone: countries that could use it won’t, while countries that would use it shouldn’t. And while unconventional monetary policies have run their course, it doesn’t look likely that Mario Draghi goes farther and drops money from the Eurotower into peoples’ pockets, which they could freely spend. Also, breaking loose from the euro in the hope of propping up demand would hardly be an idea that any country would entertain at such time of high uncertainty (especially after Brexit).
So what’s left?
“Fiscal money” is what we propose.
We define “fiscal money” as any claims, private or public, which a government accepts from holders to discharge their fiscal obligations either in the form of rebates on their full value (tax discounts) or as effective value transfers to the government. Fiscal money claims would not be legal tender, and could not be convertible by the government into legal tender. However, they could be negotiable, transferable to third parties, and exchangeable in the market at par or below par with respect to their nominal value.
Fiscal money can be introduced in several different forms. Our preferred option is to issue it as Tax Credit Certificates (TCC). TCC would entitle bearers to reduce their taxes starting two years from issuance. Being transferable, the TCC would trade for euros that could be immediately spent to buy goods and services. People selling TCC would spend their euro equivalent, while people buying them would acquire a right to future tax savings. Financial intermediaries would buy TCC at a discount from those wanting to sell them, and would either use them for future tax savings or sell them at a lower discount for a profit. The two-year deferral would give people time to spend their TCC and for output to grow in response to the income multiplier effect, thereby avoiding the euro shortfalls that TCC tax rebates would cause the government to incur in the absence of other revenues.
A Eurozone member country could start issuing TCC in 2017 in the order of 1.5-2% of GDP, and assign them (free of charge) to:
- employees and low-income households, thus increasing their after-tax incomes
- enterprises, thus reducing their gross labor costs, and
- fund / co-fund social expenditures and public investments.
Assigning TCC to liquidity-constrained people with a high propensity to consume ensures that the assignments would be used to support consumption. On the other hand, the reduction of gross labor costs would improve the external competitiveness of domestic enterprises. Similar to currency devaluation, it would increase exports and import substitution, and offset the effect of higher internal demand on the trade balance.
TCC issuances could be gradually increased up to the level needed for the economy to exit the liquidity trap and restore full employment. In a simulation run last year, taking Italy as an example and assuming that the government would issue TCCs for €20 billions in 2016 and additional €40 billions each year from 2017, investment bank Mediobanca estimated that GDP growth would reach 3% in 2016 (with a 1.2 multiplier), generating new fiscal revenues enough to cover the budgetary shortfall due to TCC redemptions already in 2017. In particular, Madiobanca estimated that the budget would record a 0.8% surplus in 2017 (against the 1.1% deficit forecast by the government), with output growth and inflation reaching 2% each, public debt setting at 112% of GDP in 2019 (against the 120% government forecast), and the external trade balance remaining in surplus (above 2% of GDP), although lower than the base case.
Why should anybody accept the TCC?
A TCC is an unconditional pledge from the issuing government to grant the holder an equivalent tax reduction. A TCC is as good as the fiat money issued by any sovereign government. It is a liquid security that carries no default risk, since the issuer does not commit to reimbursing it in euro. And it carries no exchange rate risk either, since the issuing government promises to take it back in exchange for a tax rebate of same euro value.
To the extent that the government promise backing the TCC is credible, there is always a demand for it, since those who do not need immediate liquidity always find it convenient to use them as tax savings. A liquid market for TCC would develop, allowing holders to convert TCC in euros based on a discount factor that would be proximate in size to that on a zero-coupon treasury bond of similar maturity.
Also, use of TCC to directly settle transactions, including for the purchase of goods and services, could become widespread.
Yes, but don’t they raise the budget deficit?
The main objection to fiscal money is that it is a form of budget deficit in disguise: the latest shortcut by those lazy Mediterraneans who don’t want to do their “homework” and look for free meals.
Stay cool. This objection has no foundation whatsoever in the European law. Here the relevant rules are those of the European System of Accounts 2010 concerning the treatment in national accounts of non-payable tax credits like our TCC. According to the rules, issuing TCC does neither originate a financial asset nor a financial liability since there is no money obligation binding a debtor to a creditor. When the TCC are issued, they only represent a contingent liability for government and should not be recorded in national accounts. They would be recorded as reducing tax revenue only when they are effectively used to pay less tax in the relevant accounting period; that is, a 2-year TCC issued in 2017 would not be recorded in the national account until it would be used for tax reduction, which would not happen prior to 2019.
So, the TCC do not raise the budget deficit when they are issued.
Uhm…but what if they don’t work as expected?
Even under extremely conservative assumptions (fiscal multiplier of approximately 0.8) the TCC program would trigger a significant GDP recovery while not increasing the public debt / GDP ratio. Under more reasonable assumptions (fiscal multiplier of approximately 1.2) the TCC would be entirely self-financing, implying a quick reduction of the public debt / GDP ratio, as real GDP recovers and nominal GDP benefit from some step-up in inflation.
In any case, the TCC program could contemplate “safeguard clauses” to fully guarantee that no increase in public deficit would ever take place as its byproduct. To take again the example of Italy, the government could, for instance, issue € 30 billions of 2-year maturity TCC in 2017, entitling the holders to benefit from € 30 billion tax discounts in 2019. At the same time, as a safeguard clause, the government would legislate new tax increases and public expenditure cuts for an equal amount (€ 30 billions), which would take place in 2019 in the event that the recovery triggered by the TCC program failed to generate enough gross tax receipts.
With the activation of the safeguard clause, two mutually offsetting effects would follow within the same year (2019), with an overall neutral impact on the budget. Yet, the expansionary effect would kick in immediately (since 2017), raising recipients’ net worth, disposable income and purchasing power.
The contractionary effect associated with the safeguard clause would take place in 2019 and only if GDP recovery is not strong enough to make it unnecessary: a very unlikely scenario, according to reasonable and even conservative assumptions on the income multiplier. (It would also be an interesting way to put the Ricardian equivalence theorem to test…)
The TCC program could also include additional flexibility tools to guarantee a steady decrease of the public debt / GDP ratio. One example of such tools would be to grant to TCC holders the option to postpone the use of maturing TCC for tax rebates in exchange for an increase in their face value (this would in practice amount to offering holders an interest rate payable in TCC). Another tool would be to refinance part of the maturing public debt stock by issuing “long-term TCC”.
Saving the Eurozone from the euro
Brexit has shown the growing estrangement and alienation of large segments of our societies, the loss of Europe’s appeal as the beacon of hope for a better future in our continent, and the inadequacy and lack of dynamism of the Eurozone’s architecture, especially for its periphery.
A positive shock therapy is needed as the only way to jumpstart growth, give people a strong signal that their wellbeing is back at the center of economic policy, and turn their expectations radically from stagnation to growth: growth only can reduce debt; growth only can improve resiliency; growth only can provide the resources to address our pressing social problems.
But the long economic depression and the lack of prospects will not be cured by structural reforms, however useful these may be. People must recover their capacity to spend and to put money in circulation. How? Where fiscal space is inexistent – like in our country, Italy – fiscal money can provide the answer. It might sound paradoxical, today, but in the early Thirties of the last century that is precisely what Germany successfully did to exit economic depression.
It is a matter of shaking off timidity and embracing audacity.