From a new paper by Antonio Fatas:The Unassuming Economist“This paper studies the negative loop created by the interaction between pessimistic estimates of potential output and the effects of fiscal policy during the 2008-2014 period in Europe. The crisis of 2008 created an overly pessimistic view on potential output among policy makers that led to a large adjustment in fiscal policy during the years that followed. Contractionary fiscal policy, via hysteresis effects, caused a reduction in potential output that not only validated the original pessimistic forecasts, but also led to a second round of fiscal consolidation. This succession of contractionary fiscal policies was likely self-defeating for many European countries. The negative effects on GDP caused more damage to the sustainability of debt than the benefits of the budgetary adjustments. The paper concludes by discussing alternative frameworks for fiscal policy that could potentially avoid this negative loop in future crises.”
Fiscal Policy and the Shifting Goalposts
Prakash Loungani | Advisor and Senior Personnel & Budget Manager in the IMF’s Independent Evaluation Office
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“This paper contributes to the open economy local fiscal multiplier literature by estimating regional output and employment responses to federal expenditure shocks in the European Union. In particular, similarly to the literature on foreign aid and growth, I use shocks to the supply of federal transfers (European Commission commitments) of structural fund spending by subnational region as instruments for annual realized expenditure in a panel from 2000-2013. I find a large, contemporaneous multiplier of 1.7 which translates into a cumulative multiplier of 4 three years after the shock. Furthermore, using a novel dataset on bilateral trade between EU regions, I find evidence of demand-driven spillovers up to three years after a shock.”
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From a new IMF policy paper:Assessing Fiscal Space: An Update and Stocktaking“This paper reviews the experience with the fiscal space assessment framework that was piloted during 2017–18. In 2016, staff proposed an operational definition of fiscal space and a new four-stage framework for its assessment. These were discussed informally by the Board in June, and a Board paper “Assessing Fiscal Space: An Initial Consistent Set of Considerations”incorporating Directors’ views was published in December. Fiscal space was narrowly defined as the room for undertaking discretionary fiscal policy relative to existing plans without endangering market access and debt sustainability. The framework was developed in response to the need to provide a more systematic approach to assessing fiscal space in the Fund’s surveillance. It was designed as a tool to inform the availability of fiscal space over a 3 to 4 year horizon for discretionary action, as opposed to the optimality of its use. Indeed, it was stressed that the availability of space does not necessarily mean that it should be used or should not be further expanded. The framework was piloted in the Article IV consultations of 34 advanced economies and emerging markets, comprising almost 80 percent of global GDP in PPP terms.”
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Fiscal space was narrowly defined as the room for undertaking discretionary fiscal policy relative to existing plans without endangering market access and debt sustainability.
Under the Gold Standard it was not practical for citizens to use their Nation's (gold-backed) fiat to any large extent since eventually gold would become too expensive for any other use. Thus, central banks could not be allowed to provide checking accounts for all citizens but only for depository institutions (banks, credit unions, etc). Instead, the non-bank private sector would be largely confined to using bank deposits and not their Nation's fiat.
The result is that the economy is unduly sensitive to fiscal spending not because of the new bank reserves created* but because the new deposits created in the banks, credit unions, etc. represent new interest to enable new credit/debt creation by the banks, etc.
Thus if we wish the monetary sovereign to have MAXIMUM price inflation space then it follows that the price inflation space consumed by banks, credit unions, etc. be MINIMIZED. And who can argue that de-privileging the banks, etc. is not the proper way to do so since the excuse for those privileges, the Gold Standard, has been, rightly so, abandoned?
*Banks are not reserve limited in their lending but by the availability of new borrowers who can repay the loans with interest.
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