An Application of Values OfMultipliers: Inconsistency of the EMU Institutions
In the EMU, monetary policy has tended to be contractionary until recently. The European Central Bank (ECB) has taken over the task that should have been entrusted to fiscal policy, i.e.
that of a better coordinated countercyclical policy action (Tabellini 2016). Thus, it is the whole institutional design - and not only current policies - that imposes a deflationary bias.The risk envisaged before the start of the EMU by Gregory and Weiserbs (1998: 48) about the ‘potential deflationary bias that the Maastricht criteria are likely to impose throughout the EU' has materialised. It has also caused a tendency to secular stagnation, resembling the situation that emerged in the 1930s as a consequence of the deflationary policies enacted by European countries trying to stay on the gold standard (De Grauwe 2015).
In addition to the conservative nature of the ECB, the bias can be deduced from at least three aspects of the EMU institutions: the content of the Stability and Growth Pact (SGP), the fiscal compact and the asymmetric nature of the scoreboard of the ‘macroeconomic imbalance procedure' (MIP) (Altavilla and Marani 2005; Acocella 2011; De Grauwe 2013; Stockhammer and Sotiropoulos 2014). Before the financial crisis, it was mainly the SGP that impressed a deflationary bias on the area. After this, the fiscal compact (formally, the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (TSCG)) and asymmetry of the limits to current account imbalances deriving from the MIP have stressed the bias.
As to the SGP, the bias derives first from the limitation imposed on the operation of automatic stabilisers in countries where they are stronger and may imply a fiscal deficit of more than 3 per cent. Moreover, the SGP does not limit public balance surpluses in a similar way. Finally, a debate has recently involved the method for calculating potential output and - as a consequence - the output gap of current output on which the structural balance depends.
According to some authors (Tereanu, Tuladhar and Simone 2014; Darvas and Simon 2015) and countries (this was the position of eight financial ministers of EMU countries in 2016), the method currently in use by the EMU underestimates potential output and imposes a deflationary bias on countries having a high deficit and debt and the whole Euro area. These are requested to implement fiscal consolidation efforts in terms of the structural balance that a country under the ‘excessive deficit procedure' (EDP) has to take.A fiscal adjustment of at least 0.5 per cent of GDP per year is required according to the SGP and a higher one is asked from countries having a debt/GDP ratio over 60 per cent. The fiscal compact established in 2011 has accentuated the contractionary orientation of fiscal rules in the EMU in a situation of lasting deflation. It prescribes a structural budget deficit not larger than 0.5 per cent of GDP (whereas it is 1 per cent of GDP for countries having a debt/GDP ratio significantly lower than 60 per cent).
As to the limits to current account imbalances, it must be first noted that before the crisis, unchecked current account balances and the surpluses accumulated by the EMU ‘core' countries moderated the deflationary environment in ‘peripheral' countries due to inflow of capital into the latter, thus issuing wrong signals to investors (Acocella 2016a). In addition, the asymmetric nature of foreign imbalances indicated in the more recent MIP (6 per cent for surplus countries, 4 per cent in case of deficit)[42] translated into a very powerful deflationary bias due to debt deleveraging when the effects of both current account and public account became clear after the financial crisis, as is well known since Fisher (1933) and Keynes (1936) and revived by Minsky (1993) and, more recently, by others, among whom Chiarella, Flaschel and Semmler (2001) and Semmler and Haider (2015).
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The mechanism is well illustrated by De Grauwe (2013).
A consumer or a firm that must reduce its debt will reduce consumption and/or sell assets. Increased saving will reduce demand, production and income. Sale of assets will lower prices, creating new insolvencies and the need for deleveraging. Both actions will frustrate the private sector's attempt to reduce its debt in a deflationary spiral unless the public sector counteracts them by increasing its consumption and taking over private debt.The effects on GDP of the contractionary policies and debt required in the EMU have recently been assessed in a number of studies. Using a Keynesian model, Stockhammer and Sotiropoulos (2014) estimate that had core countries expanded their public budgets or raised their wages, a high loss in the GDP in peripheral countries would have been avoided. If, by contrast, in 2007 these countries were required to fully eliminate their current account deficits by deflationary measures, the cost would have been on the order of 47 per cent of their GDP.
Rannenberg, Schoder and Strasky (2015) have applied the analyses of multipliers developed by Coenen et al. (2012), Gechert and Mentges (2013), Gechert (2015) and Gechert, Hughes Hallett and Rannenberg (2015). Gechert, Hughes Hallett and Rannenberg (2015) calculate the fiscal multipliers of tax increases: these lower GDP by around 1, whereas expenditure cuts have a similar, but higher, effect on GDP, as their multiplier has been estimated at about 2.5 on average, in depression years. They find that the cumulative measures of consolidation in the EMU in the three years up to 2013 have been roughly equal to a reduction of almost 4 per cent of the EMU GDP. By applying the appropriate multipliers of different expenditures and taxes, a cumulative negative effect on GDP of almost 8 per cent in the same years has been calculated. The budget balance effect would have been a meagre 0.2 reduction. The mountain has thus laboured and brought forth a mouse. More generally, if cumulative multipliers are applied to estimated changes in the individual fiscal instruments, the Euro area's fiscal consolidation effort reduced GDP by 4.3 per cent relative to the no-consolidation baseline in 2011 and by 7.7 per cent in 2013.
Thus, austerity came at some cost. The biggest contributor to this GDP decline came from transfer cuts, not surprisingly, given their high multiplier and their high share in the overall consolidation effort.According to Rannenberg, Schoder and Strasky's (2015) simulation, in the three years after 2010, Eurozone GDP had decreased by almost 6 percentage points with respect to the pre-crisis trend. This could be explained by one-third or one- half in terms of fiscal consolidation, and these fractions increase to almost two-thirds and more than 80 per cent.
An application of Gechert and Rannenberg's (2014) and Gechert, Hughes Hallett and Rannenberg's (2015) methodology to the policies that have been imposed on Greece to ‘remedy' the crisis shows that austerity had a very heavy negative effect on the economy of this country, which has entered a profound depression because of it. First, the measures prescribed since 2010 implied a total reduction in public expenditures in Greece of about 30 billion euros - and an increase in revenues of about the same amount - in the five years following 2009. By combining the multipliers found by Gechert, Hughes Hallett and Rannenberg (2015) with the fiscal consolidation measures prescribed for Greece between 2010 and 2014, Gechert and Rannenberg (2014) explain ‘almost the entire collapse of Greek GDP after 2009'. The reduction in GDP has been above 25 per cent with respect to the level in the absence of fiscal consolidation. As a consequence of this reduction, the debt/ GDP ratio has increased by slightly less than 2 per cent compared with what it would have been in the case of no consolidation and more than in the case of consolidation based only on taxes.
Simply postponing this to a period when GDP had returned to its growth path should have ensured the desired consolidation. In fact, ‘if the consolidation would have been postponed until after the recovery of the Greek economy and implemented gradually, almost 80 per cent of the cost in terms of lost output could have been avoided' (Gechert and Rannenberg 2015: 2). The reason stays simply in the variability of multipliers, which are very high in times of recession and lower in normal times, as a cut in expenditures would have depressed the economy less. For recessions of -4 per cent of GDP, Bilbie, Monacelli, and Perotti (2014) find that the optimal increase in government spending is about 0.5 to 1 per cent of steady-state GDP. For recessions implying a fall in GDP on the order of 28.8 per cent and a high annual deflation - such as for the Great Depression and not very different from the situation in Greece - the optimal increase in government spending at the ZLB is about 14.5 per cent (13.5 per cent if public expenditure is wasteful) of GDP.
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