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An easy way out for Italy

Just finished reading the interesting section on the prestigious Journal of Economic Literature over the issue of “What is the Size of the Fiscal Multiplier – Can  Government Purchase Stimulate the  Economy” (if the multiplier is 2, for  example, a 1% increase in government expenditure causes a 2% increase in GDP).

What comes  out of it, in my mind, is the confirmation that Italy can only escape this economic  crisis by implementing a daring plan of fiscal expansion based on public consumption  expenditure. Reforms, just like public investment, will save the day only in 10  years time, they are useless right now.

What does economic research say? When public spending is financed with taxes, when the  economy is in a good state and interest rates do not reach the zero-bound, then  the fiscal multiplier is low, around 0,5. When public spending is financed in  deficit, in times of crisis or when the zero-bound limnit is reached for  interest rates, then public spending impact is strong with a multiplier on  average around 1,5. My take? What better moment than now to have Italy embark in a daring program of public purchases of goods and services!

Interestingly,  research also suggests that:

a)  in a monetary union the  redistribution of resources from a low unemployment state to a high unemployment  state  would carry high aggregate fiscal  multipliers for the Union (so Germany should lend to Greece or Italy for that  purpose, just to make things clear). Careful though not to make such transfers  useless like it happened with the ARRA Obama Plan, where states instead of  spending decreased lending from other sources and did not invest in the economy  the additional funds.

b)  The fiscal multiplier is stronger  when demand is directed at liquidity constrained firms and individuals.

So here is my  simple (and well disliked in Europe) plan to have Italy sort out its internal  mess through higher immediate growth: Increase  by 25% public consumption of goods and services (approximately by 2% of GDP) in  2012, financing it 50% by cutting waste in procurement (well documented by Bandiera  Prat and Valletti in their American Economic Review paper, equal to
approximately 1.6% of GDP) and 50% by an increase in the size of the deficit or  with a long-term loan from the European Union at German rates of interest. Concentrate  such procurement only on SMEs – today highly credit constrained – mandating also  a mandatory maximum payment delay for those of at most 60 days. The following  increase in GDP will allow deficit and debt to GDP ratios to crumble and will  cause a rapid decline in spreads, which will additionally contribute to the
virtuous circle of stability through growth.

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