BIZweek n°275 31 jan 2020
BIZweek n°275 31 jan 2020
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  • Parution : n°275 de 31 jan 2020

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  • Editeur : Capital Publications Ltd

  • Format : (260 x 370) mm

  • Nombre de pages : 10

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VENDREDI 31 JANVIER 2020 BIZWEEK ÉDITION 275 J it 4.1F-.5 book, the Euro the first decade in collaboration with Servaas de Roose, Marco Buti and Joao Nogueira Martins (2010). Now that I have established beyond reasonable doubt that I am old let me move on. Having recourse to fiscal discipline POST SCRIPTUM 3043 "Ute,2, T‘à ulr.i. ro, ti Over time, the fiscal rules in Europe have become more complex and opaque. The evolution process followed a long and winding road. Changes to the original setup of the fiscal framework were frequent and substantial. Blanchard, Leandroand Zettelmeyer (2019) compared the evolution of fiscal rules with the Cathedral of Seville. But I believethe complexity of the evolution of fiscal rules is even better captured by the evolution of another building also in Andaluzia, Spain : Mosque-Cathedral of Cordoba. It is a building that integrates successive layers of building spanning a full millennium. In the area of fiscal rules more layers were built in a period thirty times shorter. It is opportune to recognize that in the remarks that follow I benefited from careful reading of the contribution by Blanchard, Leandroand Zettelmeyer (2019). My debt goes well beyond Medieval Andalusian architecture. It is, I believe, opportune to revisit the analysis on fiscal policy included in the Delors Report. The main contribution was a paper, submitted by Alexander Lamfalussy (and produced in collaboration with his team at the Bank for International Settlements (BIS)). The title : Macro-coordination of fiscal policies in an economic and monetary union in Europe (1989). It made two fundamental points : first, given the insignificant size of the EU budget, the task of defining a Union-wide fiscal policy stance had to rely on the coordination of national budgetary policies. Second, fiscal discipline is necessary. Financial markets can exert some disciplinary influence. But they are not sufficient : «The constraints imposed by market forces mighteither be too slow and weak or too sudden and disruptive.» The conclusion was that sharing a single financial market and a single currency implied the need to accept constraints on the conduct of fiscal policies. Market turmoil For the purpose of my talk today it is interesting that both elements of Lamfalussy’s analysis proved problematic in actual practice. In the slide we have a perfect illustration of the too slow and weak market discipline in the period from 1999 to 2007. And quite sudden and disruptive in the period of the sovereign debt crises in the euro area. The rules did not prevent the market turmoil that they were designed to avoid. Despite the governance reforms implemented over 2005–13, such as increased flexibility, greater automaticity in enforcement, and greater ownership supported by revisions in national legislation, compliance track record with fiscal rules has been very poor. Here we follow Eyraud et al, 2017. The idea is simply to compare fiscal results with four simple numerical references (disregarding the complications, qualifications and judgement allowed by the fiscal framework). Under these simplifying conditions : the MTO was violated in 80 percent of observations under consideration, with almost two-thirds of countries exceeding the MTOs in every single year. Compliance worsened during the crisis : in 2009, the 6 FrA MTO rule was violated by 90 percent of countries, the debt ceiling by 50 percent of countries, the deficit ceiling by 85 percent of countries, and the required fiscal effort by 75 percent of countries. In parallel, the share of countries with a debt ratio greater than 60 percent increased from 35 percent in 1999 to 75 percent in 2015 There are a number of important caveats and qualifications to this summary that are spelled out in Eyraud, Gaspar and Poghosyan (2017). Designation of fiscal rules Our analysis of the compliance with 3-percent deficit rule over the three-year planning horizon suggests that the main driver of poor ex post compliance was weak execution of plans. Given that the EC has not applied any fines or sanctions, this is also a sign of weak enforcement. Although the noncompliers consistently planned to reduce their deficits below the 3 percent threshold set out by the rules in each of the projected years, execution slippages more than offset these plans, leading to a medianupward deviation from the ceiling ofup to 2 percent of GDP at the end of the third year. I summarize Edward Prescott’s intuition about commitment through rules as : first, societies must find good – but often time-inconsistent – policy rules ; second, societies have to find a way to stick to these rules. The evidence presented on the frequent revision of the rules and poor compliance suggests that we are far off Prescott’s standard. European fiscal rules did have effects. They may not have worked as intended but – still – they did affect policy-making. That is clear in the process leading to the start of the euro area. But here I want to quote an interesting result documented by Caselli and Wingender (2018). Cont’d on page 7
VENDREDI 31 JANVIER 2020 BIZWEEK ÉDITION 275 They show the 3-percent deficit rule ceiling did not act as anupper bound but more as a target or a «magnet». The number of observations around the threshold increased, reducing the occurrence of both large government deficits and surpluses. One of important features of the fiscal rules is to make sure that countries accumulate sufficient buffers in good times so as to be able to provide support to the aggregate demand in bad times – through automatic stabilizers or even discretionary expansionary policy. In other words, fiscal rules should be designed to favor counter-cyclical fiscal policies. Nevertheless, despite various amendments to strengthen the counter-cyclical features of the rules, the outcomes have been mainly pro-cyclical. At the individual country level fiscal policy was procyclical in most countries most of the time. The right-hand-side chart shows most country-year observations of structural primary balances fall in the two quadrants that correspond to procyclical policies (almost 60 percent of the total). Persistent divergences These charts using the Industrial Production Index to compare the Great Depression and the Global Financial Crisis follow an original contribution from Barry Eichengreen and Kevin O’Rourke to VoxEU. The original idea was to show that the turning point happened much earlier in the Global Financial Crisis (likely due to effective policy action). The idea then was to prolong the comparison to show that the recovery may have come earlier but has not been strong (a point made in Barry Eichengreen’s Hall of Mirrors). These charts show the behavior of industrial production following the start of the Great Depression in 1929 and the start of the Global Financial crisis in 2008. It is remarkable that industrial production in the Euro Area is yet to recover to pre-crisis levels. That remind us of the words of Alvin Hansen, in his Presidential Address, delivered to the American Economic Association, in December 1938 : «This is the essence of secular stagnation – sick recoveries which die in their infancy and depressions that feed on themselves». In a secular stagnation there is excess of savings over investment. In addition, economic performance within the Euro area was very uneven. Persistent divergences have occurred. This is best illustrated by contrasting real per capita GDP growth in Germany and Italy. Over the last twenty years Germany experienced a very strong real per capita GDP growth, above the average for the Euro area and at the level that of the United States. In contrast, real per capita GDP in Italy is almost at the same level as twenty years ago. Economic growth a must Importantly, the growth performance was similar in the first years of the euro area. But afterwards, following the implementation of structural including the labor reforms, Germany was well prepared POST SCRIPTUM to weather the global financial crisis (e.g. Krebs and Scheffel, 2013). In contrast, in Italy structural impediments to growth contributed much to the disappointing economic performance. That became very visible since theonset of the global financial crisis. Germany is the issuer of the reference safe assets in the euro area. Surprisingly, over the last twenty years, the average structural primary surplus in Italy was 1½ percent of potential GDP, against 0.9 percent for Germany. Nonetheless, Italy is characterized by high and rising public debt. In contrast, in Germany debt is quickly declining. Between 2010 and 2019, Italy’s gross debt-go-GDP ratio increased by about 18 percentage points. During the same period, debt in Germany declined by 24 percentage points of GDP. Low growth and high cost of debt are primary reason why Italy has not managed to escape from vicious circle of high public debt. Italy is also quite sensitive to changes in market sentiment as evidenced by significant swings in sovereign bond yields. Interest rate-growth differential, on the other hand, is very favorable in Germany thanks to record-low and negative interest rates. Using an extended accounting approach that fully recognizes the importance of economic growth (which keeps track of the impact of growth on primary fiscal surpluses) Mauro and Zilinsky show that differences in growth rates are key in determining changes in the debt-to-GDP ratios (Mauro and Zelinsky, 2016). To facilitate change and transformation Going forward, long-run competitiveness and prosperity in the Euro area requires deep transformation towards green and digital economy and society. This requires higher public investment, more extensive synergies with private investment and, more generally, smart and agile public policies that facilitate change and transformation. For example, the outline of a EU’s Green Deal, presented by the Commission on December 11, 2019 provides a list of 50 initiatives designed to achievecarbon neutrality by 2050 in a sustainable growth framework. It is clear that the transition toward carbon neutrality requires substantial investments. The IMF database on public sector balance sheets shows that the general government net worth has, on average, worsened in euro area countries, since 2000. The median general government net worth moved – roughly - from positive 20 percent of GDP, in 2000, to negative 20 percent of GDP, in 2016. As the righthand-side chart shows, there are significant differences between the change in net worth and the increase in gross debt. European countries have relatively low level of public sector net worth. Targeting public sector net worth is used in New Zealand. The similar approach has recently been proposed by some authors as part of new fiscal frameworks (see for example, Hughes and others, 2019). The recent improvements in fiscal reporting to hold governments to account for the value of assets created by public investments provides an opportunity to go beyond the traditional debt and deficits. Policymakers need to understand the extent of the public sector fiscal exposure through state-owned enterprises, public-private partnerships, pensions and guarantees (IMF, 2020 ; Detter and Fölster, 2015). The Public Sector Balance Sheet Aging societies change the political equilibrium by tilting spending preferences in favor of the elderly. This makes reforming programs such as pensions, even more difficult. Such reforms are necessary because pressures stemming from age-related spending will increase in the decades to come. The Public Sector Balance Sheet (PSBS) approach offers a framework to discuss the implications from macroeconomic changes. For example, low interest rates make the situation even more challenging. The present value of future cash-flow commitments increases. Pre-funding pension obligations becomes more expensive. This was emphasized by Alan Auerbach (2019), at the fourth ECB biennial conference on fiscal policy and EMU governance. His presentation was on the future of fiscal policy. Any prudent fiscal framework has to account for the future burden associated with policy commitments (mostly pensions and health). Something that would have surprised me in 1989 would be to be told that negative interest rates on bonds would be common in thirty years’time. In the early 1970s, with the US exiting from Gold Standard in 1971 and theonset of the fiat money regime, inflation increased in most countries. The period became known as the Great Inflation. That was followed by an active, successful disinflation – with Paul Volcker as Fed Chairman - from 1979. Eventually, inflation entered an enduring declining path globally. As a result, nominal interest rates have fallen significantly. Even if we take a very long-termhistorical perspective, nominal interest rates have never been this negative before. This is true for all major advanced economies, including the euro area countries. Overall price stability The prevalence and the persistence of low rates have encouraged some scholars to start questioning the conventional wisdom about the costs of deficits and debts. For example, in his American Economist Association presidential lecture Olivier Blanchard (Blanchard 2019) argued that with interest rates so low including relative to growth rates, «the issuance of debt without a later increase in taxes, may well be feasible.» The purpose of the lecture, according to Blanchard, was to allow for a richer discussion of debt policy and appropriate debt rules. In doing so we are following John Hicks. In a little known paper, The Classics Again, he explains that under Wicksell’s policy interest rule approach the LM curve is horizontal in the (Y,i) space. He, then, goes on to argue that Keynesian and Classic Economics diverge 7 Cont’d on page 8

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