Wednesday, 10 September 2014

Draghi and fiscal demand stimulus: he's not serious

Mario Draghi's speech in Jackson Hole last month has been widely seen (one more auf Deutsch) as a bellwether, particularly for his discussion of the importance of increased demand to ward off deflation and create growth.

In plain language, Draghi seemed to many to be saying: austerity plus structural reform is not going to work; Germany needs to spend more and stop raising a fuss about budget deficits elsewhere in the Eurozone. 

I would have parsed the words of the speech differently, but in any event a better way of judging how serious Draghi is about promoting fiscal demand stimulus is to look at how he acts. And I think the evidence of the succeeding weeks strongly suggests that bringing fiscal stimulus to pass is low on his list of priorities. 

We have some information on how the ECB leadership has acted when it wants to promote particular fiscal or other policies on the part of Eurozone national governments.

  • It makes maximum use of its bargaining leverage, conditioning its monetary actions on government policy.
  • Rather than viewing the Eurozone's governing treaties as a given, it advocates changes--as Draghi did when pushing the fiscal compact or more recently in his call for more centralized control over structural reform. 
But we don't observe anything like a parallel assertiveness in pushing for fiscal stimulus at Draghi's recent press conference or anywhere else. A counterfactual Draghi pushing stimulus with similar forcefulness would have
  • Tried to exert leverage over German policy, for instance by throwing his weight behind the application of external mandates and financial penalties to reduce the German trade surplus (which would require stimulus of German domestic demand). After all, this is part of the legal framework of the Eurozone, for other parts of which Draghi isn't in the least hesitant to advocate. He might even have hinted that monetary policy measures known to annoy Germany would be needed if these rules were not followed.
  • Stated that should budgetary rules not give sufficient flexibility to stimulate demand, they ought to be changed.
Instead of this, what did we observe? (From last week's press conference.)
  • Draghi declined the opportunity offered by a questioner to address the need for expansive policy in Germany and other countries with low budget deficits.
  • He stated "the Stability and Growth Pact [setting out budget-balance rules] is our anchor of confidence ... [and its] rules should not be broken," and went on to say that "... discussions on flexibility should not be viewed or should not be such that they would undermine the essence of the Stability and Growth Pact." 
Draghi's example of how one might use the flexibility of the SGP is also indicative of how distant he is from serious demand-stimulus advocacy:
Within the Stability and Growth Pact, one could do things that are growth-friendly and also would contribute to budget consolidation, and I gave an example of a balanced budget tax cut. Reducing taxes that are especially distortionary, where the short-term multipliers could be higher, and cutting expenditure in the most unproductive parts, so mostly, actually not mostly, entirely, current government expenditure.
Since tax cuts put money in the hands of people already known not to be spending or investing enough, they're ineffective stimulus policy, even more so when offset by spending cuts. And how does Draghi support the idea that this sort of policy might be good for "business confidence and private investment ... [even] in the short-term," in the words of his Jackson Hole speech? Who's that hiding in footnote 15? Yes, it's Alberto Alesina (more).

Draghi did announce sweeping new monetary policies measures last week. But it don't mean a thing if you just push that string. People who think Draghi is on the side of the demand-stimulus promoting angels now (including Krugman) are misreading the situation badly. The ECB went to war for austerity and structural reform--it could do the same for stimulus, but it isn't. 

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