In a recent column at VoxEU, Francesco Giavazzi and Guido Tabellini argue for a concerted European stimulus policy to bring the Eurozone out of recession and low-inflation. Their plan consists of three parts, cutting taxes by about 5 per cent of GDP in each country, financing the resulting budget deficits by new long-term (30 year) bonds that are to be bought by the ECB in a sort of limited Quantitative Easing. while temporarily suspending the deficit criteria of the stability and growth pact. Giavazzi and Tabellini argue that tax-cuts are less likely to cause misallocations and corruption and that the ECB will start a QE programme anyway in roughly half a year’s time, when they see that this is the Eurozone’s last means to overcome the slump. While I in principle agree with their analysis, I consider their advice only half plan because they do not even consider supply side reforms.
As you can see from the chart, the Eurozone countries that underwent supply side reforms (unfairly dubbed ‘austerity’) do fare well, while those that didn’t reform, fare not so well. Especially Germany is a reason for concern, because our politicians do ‘stupid shit’ like reviving planned economy with the Energiewende, introducing a high minimum wage, reversing a necessary pension reform and failing at crucial necessary policies such as a tax reform and investment in public infrastructure – but Germany and its incompetent government is another topic.
Still, the chart shows that supply side reforms are working. They would work even better, if they were conducted in times of high economic activity and not in one of the worst slumps ever, but maybe (!) we can help the reforms achieving their effect by conducting expansionary policy along the lines of Giavazzi and Tabellini. But their plan alone will not work, especially it will not work in Italy, where reform is most needed.
Accompanied by structural reforms, Giavazzi’s and Tabellini’s plan however sounds reasonable. While QE would probably violate the treaties, a very strict and narrow QE programm could be ruled acceptable by the courts, i.e. buying 30-year bonds worth five per cent of GDP to finance the tax cuts is no broad, general QE like the Fed programme. Also favouring tax cuts over public spending is sensible to avoid misallocation and corruption. However that may not be efficient in every case. Germany for example is in dire need of investment in traffic infrastructure (from railroads and Autobahnen to locks and canals) and broadband and mobile internet connections. Still misallocation would also be a problem in Germany but less so corruption. However, given the sheer amount of investment needs, the magnitude of misallocation should probably be small.
Still, suspending the deficit criteria due to the planned budget deficits runs counter to any progress the Eurozone made during the last couple years to stabilise the budgets of its members. A deficit is a deficit and the procedures dealing with one should be applied in any case – not least to give an incentive to governments to stick to the plans of structural reforms. For it is these reforms that will rescue the Eurozone’s economies. Spending lots of central bank money is no substitute and never will be, it may only make the task a little easier.