Download The Death of Fiscal Policy

Jesper Jespersen Professor Roskilde Universitet, Email: [email protected] Monday, 19 October 2015 Preliminary paper for the Berlin Conference, 23. – 25. October 2015 The Death of Fiscal Policy Caused by permanent public sector structural budget balance. Introduction The Treaty of the European Union has a number of public sector budget rules, which are codified in the stability pact and the fiscal compact. Legally these budget rules are binding for countries which have given up their own currency in exchange of the euro. EU‐countries, with their own currency, have accepted the principle (except Britain and The C and reinforced by the strict inflation targeting policy of the European Central Bank and the single currency adopted by 19 member countries. Originally, the required convergence criteria and the Stability Pact related to becoming members of the European Monetary Union had focus on the public sector budget (3 per cent of GDP) and to a minor extent on the size of the public sector debt (60 per cent of GDP). But, as a reaction to the excessive budget deficits, which occurred during the present crisis one more requirement related to the structural public budget was suggested by the German government. Germany had herself passed a constitutional law, which set a balanced public sector budget as a legal binding target, which is only allowed to be violated in exceptional cases. This new instrument is meant to secure that soft‐hearted (or selfish) politicians during the down‐swing of the business cycle do not undertake 'irresponsible' discretionary expansion of public expenditures. This idea of an extra fiscal control was presented by the orthodox economists (and the German government) as an act of 'sound' public finances dressed up in a set of mutually binding rules under the name of the Fiscal Compact. The major requirement is a strict limit to the so‐called Structural Budget, which in theory is an indicator of the size of discretionary fiscal policy. In principle the Structural Budget is a calculation of 1 the budget balance corrected for the impact of automatic stabilizers. One sees it often characterized as the budget without business cycle effects. The Fiscal Compact restricts active fiscal policy. Independently of where in the business cycle the economy happens to be the structural deficit is limited to ½ percent of GDP. Hence, signing the Fiscal Compact meant in practice a denouncement of the use of any expansionary fiscal policy. This amputated fiscal policy has left EU‐member states, which have adopted the euro, to the mercy of the European Central Bank with regard to any expansionary demand management policy. Different definitions Public Sector Budget Balance Of course, different definitions can be appropriate, but their usefulness and analytical relevance might be challenged. In addition, during the last fifteen years specific budget definitions has been written into European Institutional laws, which make them – at least in principle – legally binding. From the very start of the European Monetary Union there has been a specific focus at the current financial balance of the Public sector – so‐called Public Sector Borrowing Requirement (PSBR). It is a consolidated measurement of all public sector current payments except for installments/repayment of existing loans. By the introduction of the Structural Budget Balance or Cyclically Adjusted Budget within the Fiscal Compact in 2012 this definition was given a prominent position as one more goal which has to be respected by the national governments in addition to PSBR (each year). The cyclical adjusted budget is defined as the PSBR corrected for the impact of ‘automatic stabilizing’ effects due to a positive or negative output‐gab (caused by business cycles). Here, one shall be aware that the structural budget cannot be observed. It is a statistic calculation relying on a mathematical model and a definition of ‘full employment’ and/or ‘zero output‐gab’. Furthermore, the outcome of the calculation depends on, how full employment is assumed to be established – it makes quite a difference whether it is through increased net‐export, private consumption or private real investment (not to speak of public sector activity). Very recently one more budget definition has got the status of a binding requirement. The budget conditions imposed on the Greek government are related to the Primary Budget, which is PSBR corrected for (net)interest payments 2 Furthermore, OECD statistics present numbers for the Undercurrent Structural budget, which is the cyclically adjustment budget corrected for specific one time payments (for instance, revenue from privatizations). Finally, OECD calculates a Undercurrent Primary Structural budget. This final concept is intended to show a kind of equilibrium (full employment, no debt) budget. Different analytical aims Public Sector borrowing requirement (PSBR) is the most frequently used concept and the legal binding requirement is among other places within the EU Stability Pact. The allowed maximum is 3 percent of GDP independent of the underlying output gab. It measures the net‐lending requirement and therefore the nominal change in public debt. Hence, automatic stabilizers are free to work in a recession up till this limit. If it is exceeded a fiscal consolidation is requested by the EU‐Commission. From an analytical point of view the relevance of lumping together all kinds of public expenses and receipts irrespectively of their purpose and economic impact is challenged. The merging of public consumption and public real investment is critical with regard to time horizon and the burden of borrowing. Future generations will in most cases benefit from public investments (especially, when they are undertaken during a period with involuntary unemployment). Many scholars (i.e. A. Truger, 2015) suggest instead a so‐called Golden Budget Rule, where public real investments are considered as expenditures with a long term pay off period and therefore could preferably be debt financed (but also made dependent of the size of the current unemployment). Whereas the accepted deficit and required surplus(!) at the public current account (consumption, social transfers minus taxes) should be made dependent on the size of the automatic stabilizers and of the output gab. This means that this measurement would vary from country to country because these conditions are different: Scandinavian countries have larger automatic stabilizers and therefore smaller business cycles. But, and this is an important ‘but’ the calculation of the output gab (and to a lesser extent the automatic stabilizers) cannot be exact. Quite the opposite one would say, because the estimation of the output gab depends on the underlying macroeconomic model, which is contested (by theory, by estimation methods and by empirical ambivalence). Structural Budget Balance or Cyclically Adjusted Budget is PSBR corrected for the impact of automatic stabilizers. As mentioned above, this is a 3 calculated/constructed – a non‐observable – number dependent on the underlying business cycle model. It is highly debatable to make a constructed number a guide for fiscal policy. As demonstrated in Jespersen, 2009 there is a significant difference between business cycle theory dependent on neoclassical general equilibrium (rational expectation) axioms or post‐Keynesian open model critical realism. Neoclassical theory assumes that the business is ‘well‐behaved’ and waves around a supply side determined output trend, which leads to the conclusion that the PSBR shall add up to zero during a full business cycle. Post‐Keynesian economics consider the output‐gab as (partly) endogenous depending on the private sector’s saving/investment balance and (partly) unknowable. In such cases the output gab cannot be considered as a constant let alone be unequivocal. Therefore, any specific size of the structural budget should not be legally binding as such a rule may destabilize the macroeconomic development. In practice, there is made a distinction between the cyclical adjusted budget and the undercurrent structural budget. The latter is corrected for selling and buying of existing real assets, for instance revenues from privatization, which only improve the budget in a single year, but does not represent a permanent improvement of the public budget. Hence, one could also call the ‘current’ structural budget a permanent full employment budget. The same reservations apply to the ‘undercurrent structural primary budget’. Here, a calculated ‘normal’ interest payment related to a constant debt/GDP ratio is deducted from the ‘undercurrent structural budget’. These observations leave an analysis based on a general equilibrium model in trouble with regard to giving a plausible explanation of, ‘what has happened’, and even worse policy recommendations derived from such a model of the kind: ‘what to do in the present crisis to stabilize the private sector and resume growth’, will be misleading. In this case where an open system analysis seems more appropriate and the private sector has considerably excess financial savings we find that the ‘structural deficit of the public sector’ is indeterminate (and irrelevant), which makes it inappropriate in any respect to be a guide to a stabilizing policy. Are these budget definitions analytically useful? It all depends on what the aim is of the analysis and of the focus points. If the aim is overall macroeconomic balance with focus on unemployment, balance of payments and inflation – the public sector budget is an endogenous variable. 4 Giving up the general equilibrium model (closed system analysis) there is no specific reason to aim at a balance public sector budget, neither the structural or the current budget. The Public sector budget is by itself not a specific interest. One could reasonable claim ‐ that the public sector budget is mainly an instrument to stabilize the macroeconomic system. Furthermore one could claim that the macroeconomic imbalances originate from the private sector which – at least in open system models – could be stabilized via economic policies (Fiscal, monetary and/or exchange rate) As mentioned above the PSBR/GDP gives an indication of how much borrowing has been added to the debt during the year under consideration. But it does not tell us, how the debt/GDP ratio has developed. As a rule of thumb one can say that if the country has a PSBR/GDP, which is larger than nominal growth rate (G) of GDP times the debt/GDP‐ratio (De/GDP) tells us, whether the debt‐ratio goes up or down: (1) If PSBR/GDP < G x (PubDe/GDP) ==> debt‐ratio falls not withstanding a PSBR‐
deficit An example, say: PSBR/GDP = 3 pct G = 5 pct. PubDe/GDP = 60 pct. Hence, in this case PubDe/GDP will be unchanged 60 pct! Because 0,05 x 60 pct. = 3 pct. If the PSBR exceed 3 pct. the debt‐ratio will increase and vice versa. (2) if the market rate of interest is fixed at the same level as the growth rate of GDP (G), then an unchanged PubDE/GDP requires that the primary budget is balanced, because the interest payment is exactly equivalent to the PSBR = 3 pct. = 5 pct x 0,60. If a reduction in the Debt/GDP ratio is requested (by the creditors) – the primary budget has to be in surplus! If GDP stops to grow in nominal terms for a while, i.e. ‘G’ becomes zero. The debt has to stop growing as well to keep the debt‐ratio unchanged. This means that 5 the current budget has to be balanced, and the primary budget in a surplus equivalent to the payment of interest. The Death of Fiscal Policy: Greek Budget balances In the attached chart of the Greek economy we see that due to interest payments the underlying primary budget (black line) is substantially better than the structural (or cyclical adjusted) current budget (red line). In fact, in the year 2014 the Greek government managed to establish a balance at the structural Budget. But due to the deep economic crisis and high unemployment the PSBR is still in deficit – and with GDP growth rates close to zero (or even negative in nominal terms) the Debt/GDP ratio is still growing. GREECE: Underlying Primary, structural & current
public sector budget
10
Primary Budget
5
Percent of GDP
Structural Budget
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
-5
Public Sector
Borrowing
Requirement
-10
-15
-20
Source: OECD, Economic Outlook, June 2015
Equation (1) explains why the debt ratio continued to grow, while the GDP growth rate was negative, because the PSBR was negative too, see attached figure. 6 The possibility of improving the Debt/GDP ratio increases, of course, if the debt is reduced. This is why, among other, IMF recommends this as a part of a total and hopefully lasting solution. Although the rate of unemployment is 25 percent in Greece there is no leeway for the Greek government to undertake any fiscal expansion, because the fiscal pact requires that the structural (cyclical budget) shall be balanced (or not show any deficit larger than ½ pct. of GDP). This requirement is independent of the rate of unemployment. The PSBR is only allowed to show a deficit cause by the automatic stabilizers up to the limit of 3 percent (Stability Pact). When the current deficit exceeded this limit the government had to make further contraction of fiscal policy meaning that the structural surplus was increased! (See blue line) This is exactly what is seen in Greece. Although the Structural Budget was balanced more contraction was required. Hence, the government was forced to make tax increases and public expenditure cuts in the middle of the deepest crisis seen since the 2nd world war. GREECE: Public Sector Budget
5
Structural Budget
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Percent of GDP
Primary Budget
-5
-10
Current Budget
-15
-20
Soucre: OECD, Economic Outlook, June 2015
But Greece’s creditors were still not satisfied. They focused during the negotiations in the summer on the primary budget and said that is should show a surplus of 4½ pct. of GDP (which after tough fight was reduced to 3½ pct. in 2017. This new request adds another 3 pct. of GDP contraction (increase in structural surplus) to the 7 already very fragile Greek economy. If the Greek government succeed in this policy, GDP will fall in real and nominal terms, which will make the Debt/GDP ratio grow even more and, of course, force the rate of unemployment up to a new extreme level. This unhappy economic development will, of course, scare private and foreign investors away, making the size of the private excess financial saving grow high, see figure below. Greece: Public Sector Gross Public Debt
200
180
Percent of GDP
160
140
120
100
80
60
40
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: OECD, Economic Outlook, June 2015
Summary I called the paper the death of fiscal policy. I should have called it ‘fiscal policy in reverse’, because this is what has happened not only to Greece, which is an extreme case. But the euro‐zone as a whole has been undertaking restrictive fiscal policy over since the Fiscal Pact was agreed upon. Even the strongest economy Germany has undertaken a fiscal contraction by 4 pct. of GDP since 2010 according to OECD‐numbers. Why has Germany done so reasonably well with regard to unemployment? She has exported herself out of crisis, which of course has been harmful to its euro‐zone partners. They have been uncompleted at their own home‐market and abroad by German Goods. Not until 2012 the euro‐zone as a whole was able to manage a balance of payments surplus viz‐a‐viz the world around. A surplus, which among other things, is caused by the expansionary monetary policy pursued by the European Central Bank. 8 Fiscal Policy, 2014*
7
6
5
ce
ee
Gr
ar
De
nm
It a
ly
k
l
ga
rtu
Po
rm
Ge
s)
tri
e
(1
5
co
un
an
y
d
l an
Ire
ia
s tr
Au
um
lg i
Be
Sp
ds
ain
a
ar
e
ro
-2
Eu
-1
l an
0
er
1
Ne
th
2
ce
3
an
4
Fr
Percent of G D P
* Underlying primary Public sector budget
But the macroeconomic imbalance in the Euro‐zone will persist as long as the private sector has a financial excess savings and the public sector is forced to balance its budget or even worse has to establish a substantial surplus by the request of lowering the debt/GDP‐ratio. This is a deadlock which causes a prolonged economic crisis with low, if any, growth and continuously high unemployment for the years to come. 9 Private Sector financial savings
15
Percent of GDP
10
5
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
-5
-10
-15
Source: OECD, Economic Outlook, June 2015
Denmark
Germany
Greece
Spain
List of Literature (tentative): Andersen, T.M. (2012): Fiscal policy targeting under imperfect information, Journal of International Money and Finance, vol. 34, pp. 114‐30 Bird, G. & A. Mandilaras (2012), Will Europe's Fiscal Compact help avoid future Economic Crisis? Discussion papers in Economics, 12/12, University of Surrey Blanchard, O. & D. Leigh (2013), Growth Forecast Errors & Fiscal Multipliers, IMF Working Paper, no.1 Blyth, M. (2013), Austerity: the History of a Dangerous Idea, Oxford University Press, 2013 Chick, V. (2012), Keynes, the Long Run and the Present Crisis, unpublished paper Greer, S. (2013), Structural adjustment comes to Europe: Lessons for the Eurozone from the conditionality debates, Global Social Policy, pp. 1‐21 Galbraith, J.K. (1958) The Affluent Society, Boston: Houghton Mifflin Jespersen, J. (2009), Macroeconomic Methodology: a Post Keynesian Perspective, Cheltenham: Edward Elgar Jespersen, J. (2013), Keynes ‘General Theory’ after 75 years: time to re‐read and reflect, chapter 9 in J. Jespersen & M.O.Madsen, Keynes’s General Theory for today: contemporary perspectives, Cheltenham: Edward Elgar. Jespersen, J. (2014), The Economic Consequences of the Euro: Lessons from History, chapter 7 in J. Hölscher & M. Klaes (eds), Keynes’s economic consequences of the Peace: a Reappraisal, London: Pickering & Chatto 10 Keynes, J.M. (1936), The General Theory of Employment, Interest and Money, London: Macmillan King, J. (2011), The Elgar Companion to Post Keynesian Economics, 2nd ed. Cheltenham: Edward Elgar Lavoie, M. and E. Stockhammer, (2012), Wage‐led growth: concept, theories and policies, Conditions of Work and Employment Series; No. 41, Geneva: ILO Moore, B. (2006), "Saving Is Never A Constraint On Investment" South African Journal of Economics, Economic Society of South Africa, vol. 74(1), pages 1‐5, Morgan, M. (2013), The World in The Model, Cambridge University Press Palley, Th. (2010): The Simple Macroeconomics of Fiscal Austerity, Public Sector Debt and Deflation, IMK Working Paper, 8/2012 Radice, H. (2014), 'Enforcing austerity in Europe: the Structural Deficit as a policy target', Journal of Contemporary European Studies, pp. xx‐xx Koo, R. (2011), “The world in balance sheet recession: causes, cure, and politics”, real-world economics review, issue
no. 58, 12 December 2011, pp.19-37, http://www.paecon.net/PAEReview/issue58/Koo58.pdf
Sawyer, M. (2015), Think Piece – Budget 2015: The Budget Surplus Rule Scam, Working Paper, University of Leeds, July Skott, P. (2015), Public Debt, secular stagnation and Functional Finance, Chapter xx in Madsen, M.O. & F. Olesen ‘ Post‐Keynesian Economics for today’, Routledge, forthcoming Snowdon, B. & H. Vane (2003), The Encyclopedia of Macroeconomics, Cheltenham: Edward Elgar Stockhammer, E. et al. (2009), Functional income distribution and aggregate demand in Euro area. Cambridge Journal of Economics, 33 (1): 139‐59 Truger, A. (2015), Implementing the Golden Rule for Public Investment in Europe, Working paper, nr. 138, Materialien zu Wirtschaft und Gesellschaft, Wien 11