Dual Currencies in the Eurozone: Stiglitz is Right - but only partially

As usual, we found Joseph Stiglitz’s last article on Project Syndicate (“Can the Euro Be Saved”, June 13, 2018) very insightful. However, there is a point on which we do not quite agree with him, namely the following:

“Italy is large enough, with enough good and creative economists, to manage a de facto departure – establishing in effect a flexible dual currency that could help restore prosperity. This would violate euro rules, but the burden of a de jure departure, with all of its consequences, would be shifted to Brussels and Frankfurt, with Italy counting on EU paralysis to prevent the final break. Whatever the outcome, the eurozone will be left in tatters”.

Our Group ("The Group of Fiscal Money": Biagio Bossone, Marco Cattaneo, Massimo Costa, Stefano Sylos Labini) actually has been very active in developing and promoting such a “dual currency” scheme, in the form of Fiscal Money.

Our proposal is for government to issue transferable and negotiable bonds, which bearers may use for tax rebates two years after issuance. Such bonds would carry immediate value, since they would incorporate sure claims to future fiscal savings, and would be immediately exchangeable against euros in the financial market, or usable as payment instruments (in parallel to the euro) to purchase goods and services.

Fiscal Money would be allocated, free of charge, to supplement employees’ income. fund public investments and social spending programs, and reduce enterprises’ tax wedge on labour. These allocations would increase domestic demand and (by mimicking an exchange rate devaluation) improve enterprise competitiveness. As a result, Italy’s output gap would close without affecting the country’s external balance.

Notice that under IFRS, Fiscal Money bonds would not constitute debt, since the issuer would be under no obligation to reimburse them in cash. Also, under Eurostat rules they would be treated as non-payable tax assets (of which many instances already exist) and would not be recorded in the budget until used for tax rebates - that is, two years after issuance, when output and fiscal revenue have recovered.

While we verified this debt-related issue extensively form both a legal and an accounting standpoint, it is also important to add that the reason for not including non-payable tax liabilities (i.e., Fiscal Money) in the Maastricht Debt is a matter of substance, not just of form. The reason is that a non-payable liability does not bear any default risk due to the lack of repayment capacity from the issuer of the liability.

Based on very conservative assumptions (i.e., fiscal multiplier of 1 and a resumption in private investments to recover half of the drop since the 2007) GDP recovery would generate additional tax revenues sufficient to offset the tax rebates. Projections show that these would peak at around € 100 billion per year, which compares to more than € 800 billion of Italy’s total government revenue. Thus, the cover ratio (that is, the ratio between government gross receipt and tax rebates coming due each year) would be large enough to accomodate for possibile shortfalls due to future recessions.

Have we found the philosopher’s stone ? Certainly not – in an economy with large resource slack, the multiplier work its effects largely on output and moderately on price. And if external leakages are contained (which increased competitiveness would do), the multiplier effects are the highest. Fiscal Money is about mobilizing unutilized resources, accelerating investments and inducing banks to resume lending.

By activating a Fiscal Money program, Italy would solve its output gap problem without asking anything to anybody. No European treaty revisions would be required. No financial transfers would be needed. Public debt would stop growing and start declining relative to GDP, thus attaining the Fiscal Compact goal.

Even if Italy were to lessen its fiscal discipline and decide to over-issue Fiscal Money, only recipients would take the hit, as the value of the instrument would fall while over-issuance would neither affect the value of the euro nor create default risk on a default-free instrument. In any case, the large cover ratio would make this scenario totally unlikely. Besides, it is only fair to remember that Italy’s inability to rein in net public spending is a false myth. Between 1998-2017, Italy has been the only Eurozone country to never achieve a primary budget deficit (other than in 2009). If anything, Italy has suffered from excessive public budget restraint, which has led to its dramatic output decline.

The Fiscal Money proposal is fully consistent with the euro rules and might very well be a permanent set-up for the whole eurozone going forward. There is just no technical or legal reason why the eurozone should be “left in tatters” as a consequence of Italy (and possibly other countries) introducing national Fiscal Money alongside the euro.