An expansion of fiscal policy in the Euro area might help to keep Italy in it

After the action or in many ways inaction at the Bank of England last week there was a shift of attention to the ECB or European Central Bank. Or if you prefer from Governor Mark Carney to President Mario Draghi. This is because tucked away in a rather familiar tale from him in a speech in Florence was what you might call parking your tanks on somebody else’s lawn. It started with this.

One is the ECB’s OMTs, which can be used when there is a threat to euro area price stability and comes with an ESM programme. The other is the ESM itself.

Actually rather contrary to what Mario implies Outright Monetary Transactions or OMTs were never required as the ECB instead expanded its bond puchases via the Quantitative Easing programme which is ongoing currently at a flow of 30 billion Euros a month. One might also argue the European Stability Mechanism has caused anything but in Greece however the fundamental point is that via such mechanisms monetary policy has slipped under and over and around the border into fiscal policy. For example after the progress in the coalition talks in Italy the financial media has moved onto articles about the Italian national debt being un affordable when in fact the factor that has made it affordable is/are the 342 billion Euros of it that the ECB has purchased. The Italy of 7% bond yields at the time of the Euro area crisis would not have reached now in the same form whereas the current Italy of around 2% yields has.

But there is more than tip-toeing onto the fiscal lawn below.

So, we need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy. Its aim would be to provide an extra layer of stabilisation, thereby reinforcing confidence in national policies.

As no doubt you have already recognised that particular lawn has been mined with economic IEDs as Mario then implicitly acknowledges.

And, as we have seen from our longstanding discussions, it is certainly not politically simple, regardless of the shape that such an instrument could take: from the provision of supranational public goods – like security, defence or migration – to a fully-fledged fiscal capacity.

The only one of those that is pretty non contentious these days is the security issue and that of course is because of the grim nature of events in that area. However the movement of ECB tanks onto the fiscal lawn continued.

But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.

All of that is true and just in case people missed it then the ECB broadcasted it from its social media feeds as well.

Why has Mario done this?

One view might be that as he approaches the end of his term he feels that he can do this in a way he could not before. Another ties in with a theme of this website which is to use the words of Governor Carney that monetary policy may not be “maxxed out” but there are clear signs of fatigue and side-effects. Mario may well have had a sleepless night or two as he thinks of his own recent words about the Euro area economy.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Where this fits in with my theme is that this is happening with an official deposit rate of -0.4% and not only an enormously expanded balance sheet but ongoing QE. Thus the sleepless nights will be when Mario wonders what  to do if this also turns out to be ongoing? The two obvious monetary responses have problems as whilst what economists call the “lower bound” has proved to be yet another mirage that is so far and plunging further into the icy cold world of negative interest-rates increases the risk of a dash to cash. The second response which ties in with the issue of policy in Germany is that the ECB is running out of German bunds to buy so firing up the QE operation again is also problematic.

Fiscal Policy

The problem puts Mario on an Odyssey.

And if you’re looking for a way out
I won’t stand here in your way.

In terms of economic theory there is a glittering prize in view here but sadly it only shows an example of what might be called simple minds. This is because at the “lower bound” for interest-rates in a liquidity trap  fiscal policy will be at its most effective according to that theory. So far go good until we note that the “lower bound” has got er lower and lower. There was of course the Governor Carney faux pas of saying it was at 0.5% and then not only cutting to 0.25% but planning to cut to 0.1% before the latter was abandoned but also some argued it was at 0% and of course quite a bit of the world is currently below that.

So Mario is calling for some fiscal policy and as so often all eyes turn to Germany which as I have pointed out before is operating fiscal policy but one heading in the opposite direction as I pointed out on the 20th of November.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

This poses various problems as I then pointed out.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

As you can see Mario is leaving the conceptual issue behind and simply concentrating on his worries for 2018. This of course is standard Euro area policy where changes come in for an emergency and then find themselves becoming permanent. Although to be fair they are far from alone from this as I note that Income Tax in the UK was supposed to be a temporary way of helping to finance the Napoleonic wars.


This speech may well turn out to be as famous as the “Whatever it takes ( to save the Euro) one. In terms of his own operations Mario has proved to be a steadfast supporter of it but the monetary policy ammunition locker has been emptied. It is also true that it means he has been something of a one-club golfer because the Euro area political class has in essence embraced austerity and left Mario rather lonely. Now his time is running out he is in effect pointing that out and asking for help. Perhaps he is envious of what President Trump has just enacted in the United States.

There are clear problems though. We have been on this road before and it has turned out to be a road to nowhere in spite of many talking heads supporting it. In essence it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds where for example Italy and Greece could borrow with the German taxpayer potentially on the hook. If anything Germany seems to be heading in the direction of being even more fiscally conservative.

If we look wider we see that at the heart of this is something which has dogged the credit crunch era. If you believe one of the causes of it was imbalances well the German trade surplus has if anything swelled and now it is adding fiscal surpluses to that. Next if we look more narrowly there are the ongoing ch-ch-changes in Mario’s home country Italy. From the Wall Street Journal.

Both parties vowed to scrap or dilute an unpopular pension overhaul from 2011 that steadily raises the retirement age. Economists say the parties’ fiscal promises, if enacted in full, would greatly add to Italy’s budget shortfall, likely breaking EU rules that cap deficits at 3% of gross domestic product. Italy’s public debt, at 132% of GDP, is the EU’s highest after Greece.

So is it to save the Euro or to keep Italy in it?


17 thoughts on “An expansion of fiscal policy in the Euro area might help to keep Italy in it

  1. Shaun,

    Seems likely that Mario’s replacement will be German so help for Italy needed before then? Macron also limited in the time available to continue to ignore EU diktat?

    • Hi Chris

      I am sure that “time is running out” by Muse is playing somewhere in Mario Draghi’s mind. Of course we do not know if the current plans for an Italian coalition will come to fruition but some fiscal expansionism will upset the ECB/ESM/EC apple cart. We do not know how long such a government might last as there is a regular turnover in Italy but things can change as Abe san has proven in Japan as he has broken the regular carousel there at least up to now. Thus it is a case of watch this space.

  2. The politicians will not admit it (as it doesn’t go down well with voters), but it seems to me that the euro can only survive if there is a common European economy, involving enormous transfers from some (northern) countries and a unified banking and taxation system.
    The current arrangement seems to have been based on the ridiculous idea that countries only joined when their economies had sufficiently converged (and, presumably, on the understanding that countries such as Greece and Germany would then be in economic harmony for ever afterwards).
    This has resulted in enormous suffering in the south, as devaluation is not possible and, in my opinion (but I don’t wish to stray into politics) the voter backlash resulting in, say, the new coalition in Italy, which is fundamentally hostile to the euro.
    Meanwhile, the ECB owns an enormous amount of debt which presumably will only get paid back in full if the relevant country stays in the euro. I am guessing that, at some point, therefore, the German public is going to have to be told that:
    1. Germany will have to support everyone else; or
    2. It has just lost a ton of money (despite all assurances to the contrary) if others leave the euro.
    It seems to me that Mario Draghi’s comments are designed to begin the process of softening up opinion…

  3. Hello Shaun,

    The Euro , such a nice idea , ruined by politics . We get a a bunch of bureaucrats , unaccountable to the public , pontificating on why things go wrong when they put on a blindfold and start throwing knives at the lady ( or man before the SJW brigade start) in front of the target…


  4. Hello Shaun,

    ” it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds…”

    I wonder why ? Germany has approx 36 billion euro surplus p.a. and QE is running at 30 billion per month so thats 360 billion p.a.

    oh dear – it will not end well


  5. My immediate reaction to this was that an obvious solution presented itself – Germany’s military is not in good shape, so perhaps they could spend the surplus on some Italian kit. Trouble is – they don’t seem to bother with much Italian kit.

    Sums it up really.

    • Hi David

      I follow some naval blogs so though I would look this up. What I found was that the Italians seem to have ordered a couple of German submarines with options for two more so the flow is the other way. Which leads to this from Defence News last October.

      “The German Navy’s six-strong fleet of submarines is completely out of commission after the only operational sub had an accident off the coast of Norway on Sunday.

      The U-35 was moved into ThyssenKrupp Marine Systems’ shipyard in Kiel after a rudder blade was damaged during a diving maneuver, the newspaper Kieler Nachrichten reported. The submarine was scheduled to participate in exercises in the Skagerrak, the strait between southern Norway, southeast Sweden and Denmark.

      The U-35 is a 212A-class boat, the same type that TKMS will build for Norway under a multibillion-dollar deal announced early this year. Italy also operates two boats of the class.”

      It is not as bad as it looks as a lot of this is the simple failure to order spare parts but it is not inspiring . Of course Germany also sold submarines to Greece….

  6. Hi Shaun
    Germany has been, is and will be between a rock
    and a hard place.
    Super Mario to quote Paul Simon is a one trick pony
    He’s a one trick pony
    One trick is all that he can do
    It’s the principal source of his revenue…


    • Hi JRH

      He’s a one trick pony
      He either fails or he succeeds
      He gives his testimony
      Then he relaxes in the weeds
      He’s got one trick to last a lifetime
      But that’s all a pony needs
      (that’s all he needs)

  7. “But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.”

    I think I saw an advert for this on the telly, I think it was called “Amigo Loans”. Says in the small print that the guarantor may lose their house for any loan secured on it.

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