By Biagio Bossone and Marco Cattaneo
Lost hopes and new realism
Today’s Eurosystem is certainly not the system that many European
citizens had in mind when they first thought about the single currency. Indeed,
they expected a system built on strong rules and discipline. Yet they expected above
all a system whose new currency - the euro - would be a symbol of and a vehicle
to further European integration, cooperation and economic prosperity. To that
vision the euro has become the biggest obstacle, proving to be an instrument of
division, a source of conflicts, and a generator of arrogance and subjugation.
For those who cultivated the dream of a unifying currency, thinking
today of reforming the EU institutions with a view to bringing them back into
that dream is pure illusion. We start from this premise. Yet, being aware of the
deep uncertainty surrounding a traumatic breakup of the system, we propose a
set of measures that would make possible within the system’s current structure to:
·
Engineer economic
recovery by those member states that are most affected by the crisis
·
Minimize the risk
of default from member states that are most exposed to debt, and
·
Allow a soft exit for
those member states that choose to leave the euro.
A fiscal plan
In an economy where the public sector may not increase spending, we
propose that the government issues special non-debt instruments, the Tax Credit
Certificate (TCCs). These certificates entitle their holders to a reduction of
taxes, fees and all other financial obligations to the public sector, two years
from their issue-date and for amounts equivalent to their face value. We will
discuss the two-year deferral period shortly. The TCCs are transferable
securities that can be traded for euros, thus making immediate spending
possible. Likely, these securities will trade at a discount of a similar size
to that on a two-year zero-coupon bond. Those who sell TCCs want to be able to
spend their value. Those who buy them acquire the right to future tax cuts (and
therefore to future savings). Financial intermediaries can buy TCCs at a
discount from those who want to sell them, and will either use them for future
tax cuts or sell them at a lower discount and make a profit in return.
TCC assignments
Individual member states of the Eurozone issue TCCs and assign them (free
of charge) to a number of social categories and for a number of purposes,
including:
·
Employees and
self-employed workers, both in the private and public sector: this adds to
their actual net income
·
Companies, based
on their labor costs: this reduces the tax wedge (and hence their gross staff
costs) and improves their competitiveness
·
Measures to
support social spending, such as unemployment benefits, integration of income
and minimum pensions, benefits for disadvantaged social groups
·
Financing and co-financing
of public investment and public works (public procurement with payments
partially or totally paid out in TCCs instead of euros).
As the state assigns TCCs to households and companies, many households will
want to convert them into euros for spending purposes. Companies, on their
side, will likely do the same or will take advantage of the lower tax burden to
lower their prices and restore competitiveness. In a depressed economy,
spending stimulated by TCC issuances will have a multiplier effect on income
and employment. Prospects of credit risk will improve and strengthen the
incentive for banks to resume lending to production and investment. During the two-year
deferral on the TCCs, new output will follow from new spending and will
generate new tax revenue that will finance the tax reduction. This will prevent
the deficit-to-GDP ratio from going up.
TCC volumes and allocations
Eurozone member states shall establish a program for the issue of TCCs,
aiming to achieve the following results:
·
Stimulating domestic
demand and consequently increase GDP and employment
·
Improving external
competitiveness of domestic production (via TCC assignments to companies): this
prevents the increase in domestic demand from resulting in foreign trade
imbalances, by supporting exports and encouraging import substitution
·
Fighting deflation
or chronically below ECB-target inflation.
The TCCs are hybrid securities...
The TCCs are not debt instruments: the issuing state makes no commitment
to repaying them in euros, it only promises to reduce taxpayer obligations by
an equivalent amount. There is no possibility, either theoretical or practical,
that the issuing state might be forced to default on the TCCs.
The TCCs are not legal tender. The only legal tender of the Eurozone member
states remains the euro. No private or public entity is obliged to accept
payments in TCCs. Bank deposits continue to be denominated in euros, and public
and private budgets and balance sheets continue to be drawn up in euros.
...yet they are a store of value and potential means of payment
While they are not legal tender, the TCCs bear two characteristics that
are typically associated with money. They are a store of value, since the right
to future tax reliefs attached to them is a source of value. And they are a
potential means of payment since, apart from legal obligations, it is likely
that the TCCs will circulate and be accepted for payment in exchange of goods
and services, provided that the payment infrastructure allows for circulation
of electronic (dematerialized) securities.
Fiscal stability
Public budget targets
The treaties that govern the operation of the Eurosystem bind member
states to attain certain fiscal targets. When general economic conditions are
bad, the attempt to achieve a reduction of the public deficit through restrictive
fiscal policies produces pro-cyclical effects. Under such effects, either the governments
fail to achieve the given targets, or they have to impose additional costs on
the society if they want to secure their achievement. The introduction of the TCCs
addresses this internal inconsistency of the Eurosystem. Each member state can
commit, for example, to maintaining a zero balance between euro receipts and
payments, as it can rely on TCC assignments to engineer the necessary stimulus.
Sustainability of the program CCF
For all countries of the Eurosystem that need to stimulate demand and recover
external competitiveness – most notably Italy, Spain and France – a TCC program
would in all likelihood be sustainable. With a fiscal multiplier (ratio of GDP
growth and TCCs issued) slightly less than one, these countries would achieve
the policy objectives described above (raise output and employment, balance
foreign trade, price stability) without worsening the deficit-to-GDP ratio. Moreover,
if the fiscal multiplier exceeds 1 (as econometric evidence generally shows to
be the case in all highly depressed economies), the program non only fully funds
itself but also generates additional fiscal resources. When two years after issuance
the TCCs start being used to reduce tax payments, the higher tax revenues
resulting from the higher level of GDP offset the decline in revenue due to the
use of the TCCs.
Safeguard clauses
However, if a government that is implementing a TCC program has
difficulty reaching its fiscal targets, due to, say, less than favorable economic
conditions, it can take a number of actions to ensure a balanced euro budget and
public debt consolidation. Specifically, it may introduce a number of safeguard
clauses into the program, which would be triggered in the event that output
growth were to generate less tax revenues than expected. The government may:
·
Announce its
commitment to finance a (presumably small) share of its expenses in TCCs
·
Compensate taxpayers
for tax raises by assigning them with new TCCs (this would be equivalent to
replacing tax increases with compulsory TCC-for-euro swaps)
·
Incentivize TCC
holders to delay the use of their maturing TCCs for tax rebate by increasing
the value of their TCC holdings (this would be equivalent to paying an interest
in the form of new TCCs)
·
Raise euro funds
from the capital market by placing TCCs with longer maturities instead of
issuing debt.
The effect of these clauses would be way far less pro-cyclical than cutting
public expenditure and/or raising taxes since, as under EU rules, they would
not drain purchasing power from the economy and would only replace one type of
assets (euros) with another (TCCs) in the portfolio of TCC holders.
Financial stability
Breaking the spiral between sovereign debt crisis and banking crisis
The introduction of the TCCs also creates conditions for reducing and gradually
eliminating another serious problem inherent in the Eurosystem. Financial
institutions, in particular the national banking systems, hold large amounts of
government bonds issued by their government. As a result, state insolvency causes
severe disruptions to them.
As TCCs starts being issued, banks can partially replace traditional government
bonds with TCCs on the asset side of their balance sheet. This progressively
lowers the risk that state default hits the local banking system.
Eurosystem monetary stability and “soft” exit option
Underperformance of fiscal targets, due to, say, less favorable than expected
revenues, may lead certain countries to increase excessively the issuance of
new TCCs (for example as they need to resort to safeguard clauses too often).
In this case, the TCCs would lose value in terms of domestic prices but that
would not affect the value of the euro, avoiding any negative impact on the countries
that do not issue (or do not over-issue) TCCs.
A country that would over-issue TCCs eventually might find itself in a situation
where the domestic circulation of TCCs would be predominant with respect to that
of euros. At that point, there will be the possibility (which might in fact be
regulated a priori) to transform the TCCs into a national currency, thus de
facto enacting a soft exit from the Eurosystem.
What would our partners think?
German leading opinion – currently personified by Germany’s Minister of
Finance Wolfgang Schaeuble – has got the point that the Eurosystem, as it is,
doesn’t work, unless Keynesian policies and fiscal transfers are adopted. But
this is taboo for Germany and the other North-European countries. In this light
one should read the wisemen report and the plan written by Schaeuble himself, both
just released. In
practice, both documents delineate proposals to strengthen the ordoliberal
rules governing the system and to provide for the exit of those members that are
not able to live with the rules. In this regard, Germany was (and still is)
ready to let Greece go.
Against this background, it would be reasonable to assume that the TCC
program might not be rejected by Germany and its satellite states, since it
would eventually allow for the exit of Italy, Spain, and probably even France. While
Germany would further on its integration with countries that can follow its
rules (the Netherlands, Austria and some others), other countries would de
facto part with the system. Yet the TCC program would ensure their debt
repayment capacity, since their public debt would rapidly decline in proportion
to their GDP thanks to the balanced euro budget rule and the safeguard clauses
discussed above.
For a new mechanism of the Eurosystem: Conclusion
A sweeping reform of the Eurosystem would require an overhaul of its architectural
design, its central institutions, and even the principles underpinning its
policies. We do not nurture such an ambition, as we see neither the premises of
it nor the countries and the leaders who can inspire it. On the other hand, we
are aware that breaking up the system might have destabilizing and potentially
dangerous and costly consequences.
We therefore propose a revision of the system, which, on the one hand, would
allow crisis countries that want to remain in it to achieve rapid economic
recovery, as well as fiscal and financial sustainability, while on the other it
would prepare for a soft exit those countries that do not want to stay in the
system or cannot live by its rules.
