Giavazzi, F. & Tabellini, G. (2014) “What macroeconomic policies for the Eurozone?“, VoxEU Organisation, 25 September.
In a recent column, the authors suggested coordinating monetary and fiscal expansions in the Eurozone through a money-financed temporary tax cut. The effectiveness of their proposal, however, has been questioned. In this column, the authors address some of the criticisms. They argue that the counter-cyclical fiscal policies adopted by the US and the UK, together with monetary easing, had a stabilising effect on output. Moral hazard due to the more lax monetary and fiscal policies is avoidable, increasing the credibility of the future spending cuts.
In his recent article on Vox, Roberto Perotti takes issue with the proposal of coordinating a monetary and fiscal expansion in the Eurozone through a money-financed temporary tax cut, which we advocated in a column on August 21 (see Perotti 2014, Giavazzi and Tabellini 2014). He does not question the effectiveness of the proposal in stimulating aggregate demand. But he argues that a temporary expansion of the budget deficit of the order of 5% of GDP cannot be credibly reversed through future spending cuts, and that reversing the temporary tax cut through future tax increases would also be destabilising, economically and politically.
Counter-cyclical fiscal policies: Stabilising or destabilising?
The policies enacted in the US and in the UK during the Great Recession flatly contradict the second part of Perotti’s argument, as shown in Tables 1a to c below. The US let its budget deficit expand by almost 7% of GDP in a single year, through a combination of higher spending and lower revenues (Table 1a). Less than half of this change was due to the effect of fiscal stabilisers, the rest reflected deliberate policy decisions. The changes on both sides of the budget were later reversed. In part because the increase in the deficit due to the actions taken to bail out financial institutions were one-off; in part automatically, as the economy recovered; and in part, through deliberate shifts in fiscal stance, such as the 2013 Sequester. Net of the effect of automatic stabilisers, federal outlays were reduced by more than 2.5% of GDP between the trough of the business cycle and now, while federal revenues net of automatic stabilisers increased by about 3% of GDP during the same period (source: Congressional Budget Office).
Table 1a. US fiscal expansion during the Great Recession
Relevant posts:
- Gogos, S. & Kosma, O. (2014) “Unemployment Rate in Greece: “The” Long Run Macroeconomic Challenge“, Eurobank Research Team, Economy and Markets, Vol. IX, Issue 6, June.
- Lima, B. C., Grasselli, M. R., Wang, X.-S. & Wu, J. (2013) “Destabilizing a stable crisis: Employment persistence and government intervention in macroeconomics“, Structural Change and Economic Dynamics, No. 30 (2014), pp. 30-51.
- Gros, D., Alcidi, C., Belke, A. Coutinho, L. & Giovannini, A. (2014) “Implementation of the Macroeconomic Adjustment Programmes in the Euro Area: State-of-Play“, Economic Policy, CEPS Paperbacks, 11 March.