Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
level of aggregate demand. In a recession, an expansionary fiscal policy involves lowering taxes and increasing government spending. In an overheated expansion, a contractionary fiscal policy requires higher taxes and reduced spending. According to Keynes, a recession requires deficit spending while an overheated expansion requires a budget surplus. 1) Discretionary Fiscal Policy. The first way this can be done is through the federal budget process. However, this process takes so long -- 12 to 18 months -- that it is difficult to match discretionary fiscal policy with the business cycle. The expansionary Kennedy tax cut of 1964 and later the contractionary Ford tax increase of 1974 hit the economy just when the opposite contracyclical policy was needed. As a result, the federal government will only use discretionary fiscal policy in a severe recession, such as 1981-82 and 2008-09. In both cases, the federal government resorted to a large fiscal stimulus tax cuts in 1981-82 and increased spending in 2008-09. Both policies created large deficits, which is the appropriate stabilization policy during a severe downturn. 2) Automatic Stabilizers. A second type of fiscal policy is built into the structure of federal taxes and spending. This is referred to as "nondiscretionary fiscal policy" or more commonly as "automatic stabilizers". The progressive income tax (the major source of federal revenue) and the welfare system both act to increase aggregate demand in recessions, and to decrease aggregate demand in overheated expansions. These automatic changes in spending and taxes will generate a deficit in recessions and a surplus in overheated expansions. The size of these automatic changes can be quite large. Iin the 2008-09 recession the deficit stimulus due to the automatic stabilizers was much larger than the stimulus created by the legislative changes in taxes and spending (discretionary fiscal policy). Monetary policy is under the control of the Federal Reserve System (our central bank) and is completely discretionary. It is the changes in interest rates and money supply to expand or contract aggregate demand. In a recession, the Fed will lower interest rates and increase the money supply. In an overheated expansion, the Fed will raise interest rates and decrease the money supply. These decisions are made by the Federal Open Market Committee (FOMC) which meets every six to seven weeks. The policy changes can be done immediately, although the impact on aggregate demand can take several months. Monetary policy has become the major form of discretionary contracyclical policy used by the federal government. A source of conflict is that the Fed is independent and is not under the direct control of either the President or the Congress. This independence of monetary policy is considered to be an important advantage compared to fiscal policy.
Note that expansionary monetary policy is commonly called "easy money" while contractionary monetary policy is called "tight money". Other terms are also used.
Source: European Commission, AMECO An outsider looking at this figure would surely conclude that if one country is likely to be hit by a sovereign debt crisis it should be the US, not the Eurozone. If there has been government profligacy (as is now often claimed to be the cause of the debt crisis in the Eurozone) it seems to be the case more in the US than in the Eurozone. Yet it is the Eurozone that is hit by the crisis. Why?
large differences between countries and that the Eurozone does not have a mechanism to deal with these differences. Let us first concentrate on the size of the differences. These are shown in Figure 2. Figure 2. General government consolidated gross debt
Source: European Commission, AMECO The differences are striking. Some countries like Greece and Italy have very high public debt levels, others such as Ireland and Spain have public debt levels that are increasing fast. This situation has raised concerns about the capacity of these countries to continue to service their debts in an environment of low economic growth. A majority of countries in the Eurozone, however, experience a debt dynamics that is benign certainly when compared to the US (and also the UK). Given the overall strength of the government finances within the Eurozone it should have been possible to deal with a problem of excessive debt accumulation in Greece, which after all represents only 2% of Eurozone GDP. Yet it has appeared impossible to do so. The reason is that there is no mechanism to internalise this problem, i.e. to automatically organise transfers to the country experiencing these problems. As a result, the Greek sovereign debt crisis was left hanging high and dry, triggering in turn contagion to other countries that the market perceived to be next in line for possible default. The contrast with the US is stark. Deficit and surplus regions also exist in the US. These divergences however are considerably alleviated by the fact that the centralised Federal budget automatically redistributes to the deficit regions without anyone noticing. It has been estimated that for every dollar decline in income at the state level, between 0.2 and 0.4 dollars flow back to the state through the federal budget (see for example Sachs and Sala-i-Martin 1989, Von Hagen 1991, and Asdrubali et al. 1996).
The recent proposals developed by the European Commission, under pressure from the German government, continue to follow the logic of strengthening the fire code rules and ignoring the need to create a fire brigade that is willing to extinguish the fire before it punishes the reckless. It is clear that this approach is not workable once a crisis erupts.
It is now repeated continuously that the source of the debt crisis in the Eurozone is the profligacy of national governments. As was stressed earlier, prior to the emergence of the financial crisis the government debt to GDP ratio in the Eurozone was declining. During the same period, private debt (households and financial institutions) increased in an unsustainable way. This is shown in Figure 3.
Source: European Commission, AMECO, and CEPS While the government debt ratio in the Eurozone declined from 72% in 1999 to 67% in 2007) the household debt increased from 52% to 70% of GDP during the same period. Financial institutions increased their debt from less than 200% of GDP to more than 250%.
y y
With the exception of Greece, the Eurozone governments were more disciplined than the private sector in containing their debt. The explosion of the government debt after 2007 was the result of a necessity to save the private sector, in particular the financial sector.
Those who say that it is government profligacy that is the source of the debt crisis are mistaken. They also fail to see the inevitable connection between private and public debt. This connection is particularly strong in countries like Spain and Ireland that have been hit badly by the debt
crisis. As can be seen from Figure 2, Spain and Ireland were spectacularly successful in reducing their government debt to GDP ratios prior to the financial crisis, i.e. Spain from 60% to 40% and Ireland from 43% to 23%. These were the two countries, which followed the rules of the Stability and Growth Pact better than any other country certainly better than Germany that allowed its government debt ratio to increase before 2007. Yet the two countries, which followed the fire code regulations most scrupulously, were hit by the fire, because they failed to contain domestic private debt.
Conclusion
It has often been said, but it cannot be repeated enough that the structural problem of the Eurozone is the absence of a sufficiently strong political union in which the monetary union should be embedded. Such a political union should ensure that budgetary and economic policies are coordinated preventing the large divergences in economic and budgetary outcomes that have emerged in the Eurozone. It also implies that an automatic mechanism of financial transfers is in place to help resolve financial crises. Mutual solidarity cannot be avoided in a monetary union, even if it implies solidarity with the sinners.