Fiscal Money as a Solution to Italian Eurowoes

Biagio Bossone / Marco Cattaneo / Massimo Costa / Stefano Sylos Labini

The strong performance of Eurosceptical parties such as M5S and Lega at the recent Italian election has been ascribed to the country’s dismal economy.

This is indeed the case. Italian GDP at constant prices in 2017 was € 100 billion below its 2007 level – a 5.5% decrease ! Meanwhile, export grew 7.8% - not a stellar performance in ten years, but a clear sign that the main culprit is lack of domestic demand. Had Italy’s GDP grown at the same rate as exports, today it would be 14% (i.e., € 241 billion) higher.

This state of affairs has caused Italy’s U-6 unemployment rate (which takes into account discouraged and involuntarily part-time workers) to be approximately 30%. There is no question that a huge output gap exists.

To be sure, the Italian economy suffers from other problems, too. Productivity growth has been miserable for the last 20 years. But, then again, this also is at least partly a consequence of depressed demand. In 2017, capital expenditure in real terms was 18.5% lower than in 2007. Low private sector demand, public budget restraints, and low capacity utilization have all had long-lasting negative effects on investments and productivity.

As fiscal rules constrain Italy’s ability to reflate demand by issuing debt, and with monetary policy being as accommodative as it gets, an alternative instrument is required. Fiscal Money provides such instrument.

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 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, the output gap would close without affecting the country’s external balance.

Notice than 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 deferred tax assets 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).

Based on very conservative assumptions (i.e., fiscal multiplier of 1 and a resumption in private investments to recover half of the drop since 2007), GDP recovery would generate additional tax revenues sufficient to offset the tax rebates. Projections show that these would peak at around € 100 billion, which compares to more than € 800 of Italy’s total fiscal 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 possible shortfalls due to future recessions.

Have we found the “philosopher’s stone” ? Certainly not – in an economy with large resource slack, the multiplier works its effects largely on output and moderately on prices. 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. Public finances would be sustainable as long as the ECB confirmed its “whatever it takes” commitment – which it would have no reason to disavow with Italy’s debt stabilized.

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 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 achieve a primary surplus in each single year (other than 2009). If anything, Italy has suffered from excessive public budget restraint, which has led to its dramatic output decline.

A strong recovery of the Italian economy (and possibly of other Southern Eurozone countries, which could replicate the Fiscal Money framework) is an indispensable precondition for Europe to cooperate effectively and harmoniously. Fiscal Money is the appropriate tool to make this objective achievable.