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The ECB’s dramatically erroneous fiscal policy

After the release of this week’s GDP figures, the debt dynamics of Europe – above all Italy – once again look ominous. Italy has the eurozone’s biggest debts and is the biggest loser from the arrangement whereby Germany profits from everyone else’s inefficiency. Without recovery, not only do its debts look unsustainable; it also becomes yet another candidate for imposed austerity and technocratic government.

It is possible that, at some point, there will be a replay of summer 2011, in which a bond market crisis has to be averted by concerted global action, but this time with Italy rather than Greece and Spain needing the bailout. Such action will be all the harder in a world where trade and financial markets have become weapons of diplomatic war, in which anti-globalist parties of the right and left have significantly more support, and where the global order looks much more worn and frayed.


A growing debate is surfacing in Italy. Related to how Italy will bring about in a very short time the reduction of its ballooning debt to GDP ratio.

It is amazing that while many seem to agree that the causes for its recent damaging growth are all related to the ratio’s denominator, nominal GDP that is, the solutions seem all related to its numerator, public debt that is.

A wealth tax on bondholders, a public debt default, a miraculous reduction via the sale of public real estate, an extraordinary agreement with taxpayers’ for a one-off payment in exchange for a 4-year  break from tax inspections. All the above solutions do not have the power to make the sovereign borrower appear, to investors,  sounder in terms of its capacity to repay the remaining debt. Spreads will thus remain high. Some of them, like default or wealth taxes, would even generate profound instability in Italian society.  

It would seem natural to argue instead in favor of raising European nominal GDP from its ashes. Sooner, rather than later, simply because the more time passes the more the chances that other suboptimal solutions as the ones described above would become inevitable. Which means that while structural reforms are a possible long-term solution for Italy, they do not represent the vital short-term solution  Europe is seeking before it sinks.

How to raise nominal GDP, the product of prices and the amount of goods and services effectively delivered, requires a two-fold strategy, argue two Italian researchers, Francesco Bianchi and Leonardo Melosi working at Duke University and the Chicago Fed who model intelligently the workings of a theoretical economy risking a persistent deflationary and recessionary trap after a first violent negative shock that has made public debt over GDP rise.

First, get monetary authorities and fiscal authorities to agree on a clearly and jointly announced expansionary plan made of budget deficits and monetary expansion to support aggregate demand and prices. Second, have them announce that once the debt-GDP ratio is back where it used to be before the shock occurred (year 2007 in our case, before the Lehman collapse) governments will comply with central banks’ stability concerns.

Now, is Europe ready for this phase? Some governments might agree on this plan, but the ECB thinks otherwise (certainly backed by some governments, like the German one, who do not feel the pain of the crisis yet). Its stubbornly failing policy, which has lead price inflation to deviate sensibly from its target value of 2%, has been one of arguing that it will do “whatever it takes” to fight the crisis (which is good!), as long as governments will do their fair share. But what is the ECB asking governments to do? Exactly the opposite of what Mssrs. Bianchi and Melosi: not to push forward with stimulating aggregate demand with active expansive fiscal policy, but to keep on fostering consolidation and deficit reduction.

See the following message contained in the last Monthly Bulletin editorial of the ECB to believe it:

As regards fiscal policies, comprehensive fiscal consolidation in recent years has contributed to reducing budgetary imbalances … These efforts now need to gain momentum to enhance the euro area’s growth potential… To restore sound public finances, euro area countries should proceed in line with the Stability and Growth Pact and should not unravel the progress made with fiscal consolidation. Fiscal consolidation should be designed in a growth friendly way. A full and consistent implementation of the euro’s area existing fiscal ad macroeconomic surveillance framework is key to bringing down high public debt ratios, to raising potential growth and to increasing the euro area’s resilience to shocks.”

The result? Operators perceive that the temporary expansion needed to come out of the crisis is NOT in the making. The moratoria on the so called Fiscal Compact is far from happening. The result: as forecasted by the two researchers, stagnation and deflation. The ECB conditioning of monetary expansion on fiscal consolidation is the reason for this sorry state of affairs.

A vast change is needed in Europe’s economic policy  if Europe is not to accelerate rather than terminate the global instability dynamics that pervade the world nowadays.

Our proposed referendum aiming at modifying the Italian law that imports the Fiscal Compact in Italy is exactly that: our contribution to changing the debate in Europe, thereby pushing institutions to change their obtuse policies and hopefully save Europe.

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