Monday, February 14, 2011

Schuldenbremse [debt brake] by Constitutional Law? No, Thanks

In 2009 the German Constitution was amended to introduce a balanced budget provision, or Schuldenbremse [debt brake]. Starting in 2016 the German federal government will be constrained to a deficit ceiling of 0.35% of GDP; from 2020 the Länder will not be permitted to run any deficit at all. An exception can be made for emergencies such as a natural disaster or economic crisis. All USA states except Vermont have a similar constitutional provision (Oregon is constitutionally bound to return to taxpayers any surplus in excess of 2%), though of course this does not stop them from incurring large debts. In any case States or Länder balanced budget commitments do not interfere with either a Federal macroeconomic stimulus or inter-state fiscal transfers, so that the restraint does not really matter all that much. There is a balanced budget provision is in the Swiss Constitution. Such a provision has been variously recommended also for the US Federal government but never achieved the support of two/thirds majority of states in both houses for it to be introduced.

Last year President Sarkozy proposed a return to balanced budget in France. On the eve of the Eurogroup meeting of 14 February 2011 the German Finance Minister, Wolfgang Schauble, leader of European Democratic Conservatives, proposed the introduction of a German-style constitutional ceiling in other EU countries. In the coming weeks the French Premier François Fillon is expected to present a Constitutional amendment committing France to a specified time-path of progressive reduction of the deficit from €150bn (2010) down to zero, to be approved by Parliament before the summer and to be monitored by the Constitutional Council.

Let us leave aside questions of the political feasibility of introducing such an amendment into a country’s constitution, and of the credibility of a government commitment to implement it.
It is clear that current levels of sovereign debt are excessive and insustainable in most EU member states, and that deficits will have to be cut in order to stabilize and reduce them. The real question is about the effectiveness of government policies aimed at expenditure-cutting and tax raising. Such policies would reduce the deficit coeteris paribus , but at the same time are bound to reduce demand and therefore GDP and tax revenue to an even greater extent: their final outcome is indetermined.

Victoria Chick and Ann Pettifor (FT, 4 October 2010), using UK data from 1918 to 2009, show that a persistent expenditure cut is correlated with a rise in the debt/gross domestic product ratio; and expansions in expenditure with a fall in debt/GDP. They explain that “
This result arises because government is not in a position to determine its own deficit/surplus. The size of the budgetary outcome depends on the plans of the entire economic system and its reactions to the government’s planned actions.

“Since the deficit is not something that government can control, setting out to reduce the deficit is to look at the problem through the wrong end of a telescope: the way to reduce a deficit in a time of unemployment and feeble recovery is to spend (preferably wisely) to promote employment and permanent improvements to our infrastructure, including our “human capital””.

“Keynes looked through the telescope the right way round: “Look after the unemployment, and the budget will look after itself.” "(Chick and Pettifor, 2010).

What is worse,
a simultaneous collective round of expenditure cuts and taxation increases is obviously going to have a greater impact on each country than its adoption by a single country – which is why the recessionary impact of deficit reduction is frequently under-estimated and neglected.

In any case, while a balanced budget might be a reasonable stance (possibly and conditionally) in an effort to stabilize public debt, surely this cannot be in a single year: not unnaturally, in 2003, approximately 90% of the members of the American Economic Association agreed with the statement,
"If the federal budget is to be balanced, it should be done over the course of the business cycle, rather than yearly."

The case for a balanced budget is often construed as a way to prevent a burden on future generations: thus fiscal stimulus is regarded as
“little more than an exercise in the redistribution of wealth from our grandchildren to today’s special interest groups” (Darrell Issa, "Obama's Keynesian failures must never be repeated“ , FT Comment, 8 February 2011)

John Eatwell commented that
“If government borrowing were indeed a burden, then real per capita income of future citizens would be reduced.”

“But where there is borrowing there is lending, so that payments of interest and repayments of capital that may result from stimulus packages are from taxpayers to lenders – no loss of real income there, just a transfer payment.”

“The assertion must therefore rest either on the argument that government spending “crowds out” private investment, not very credible with the current output gap and interest rate policy, or that there is a behavioural link from current borrowing to present and/or future levels of investment and growth.”


“It is possible to build models and select empirical evidence that go either way. What is not possible is to make the unambiguous assertion of future “burden”.”
(Burden on our grandchildren’ is ambiguous talk, FT Letters, 10 February).

The “crowding out” idea is indeed what lies behind advocacy of balanced budgets : public expenditure multipliers are deemed to be small, less than one, “close to zero” according to Barro. Individuals are believed to follow the principle of Ricardian equivalence: when government reduces expenditure today they expect lower taxes in the future and therefore they rush at once to work, earn and spend more . Thus fiscal consolidation is deemed to be expansionary, see the latest “Public finances in the EMU” report, or Rother, Schuknecht and Stark, “The benefits of fiscal consolidation in uncharted waters”, ECB, (2010).

However, recent empirical work (such as Christiano, Eichenbaum and Rebelo, “When is the government spending multiplier large?”, 2009 or Corsetti, Meier and Mueller, “What determines government spending multiplier?”, 2010) has shown that public expenditure multipliers “
are likely to be much larger, between one and two, when monetary policy is at the zero lower bound, when exchange rates are fixed and when a large number of households are credit-constrained. This is more or less the case in the current situation: a number of countries are experiencing de-leveraging by households, the central bank’s interest rate are low, preventing an accommodation by the central bank of a budgetary contraction, and the Eurozone countries have, by definition, fixed exchange rates.” (Raphael Cottin, Public finances in 2011: happy austerity, Eurointelligence.com, 28.01.2011).

Cottin notes that the European Commission services implicitly recognize this: the latest “Public finances in the EMU” report mentions (Part III, section 6) that fiscal expansions are likely to be expansionary under the current conditions: “but the symmetrical argument, that fiscal consolidations are likely to be contractionary, is carefully avoided.”

The Italian writer Vittorio Alfieri (1749-1803) is famous, among other things, for having himself knotted tightly to his chair with rope, in order to discipline himself to hard work and uninterrupted study. This is traditionally taken as evidence of his strong will, as claimed in his celebrated statement "Volli, sempre volli, fortissimamente volli". Surely if Alfieri really had such a strong will he would not have needed to be tied so tightly to his chair. Sarkozy and Schauble may tie themselves and their own budget in knots but leave other member states alone to pursue a more rational and enlightened fiscal policy.

8 comments:

Carla said...

Constitutions come and go, "lasciano il tempo che trovano". Art. 4 of the Italian constitution decrees everybody's "right to work", yet Italian unemployment runs at over 8%. Adding a constitutional public deficit ceiling would make no difference.

D. Mario Nuti said...

Actually, Carla, 11% unemployment if you include laid-off workers, 29% youth unemployment, not to speak of discouraged workers who no longer even seek employment.

Art. 4 of the Italian Constitution is a misrepresentation. There can be no right to work without a parallel obligation to employ on somebody else's part. So it would need either free access to employment in any enterprise of choice on the part of job-seekers, or a public Employer of Last Resort. Both schemes have been suggested in the literature, but neither is available in Italy or anywhere else in the world. Therefore a right to work is an impossible stipulation. Contractual impossible stipulations are null and void in civil law. So should art.4 be considered as null and void.

To represent correctly Italian reality Art. 4 should read:

"The Italian government should pursue a high and stable level of labour employment,subject to the inflation target independently decided by the European Central Bank and its associated policies, and the fiscal constraints of the Growth and Stability Pact".

The pious wish expressed by Art. 4 today, however, does not do any harm: it does not cause unemployment. A constitutional ceiling on public deficit, if taken at all (even half-)seriously, could and probably would cause unemployment.

chilosi said...

"It is clear that current levels of sovereign debt are excessive and insustainable in most EU member states, and that deficits will have to be cut in order to stabilize and reduce them. The real question is about the effectiveness of government policies aimed at expenditure-cutting and tax raising. Such policies would reduce the deficit coeteris paribus , but at the same time are bound to reduce demand and therefore GDP and tax revenue to an even greater extent: their final outcome is indetermined."

Then, if you were the Italian minister of Finance, what would you do: reduce tax rates and increase public expenditure, relying on the twin miracles of the Keynesian stimulous and of the Laffer curve for reducing, instead of increasing, the deficit?

As to the idea that the debt service is a simple transfer, it is a transfer that must be financed through higher tax revenue and/or by diverting part of future public expenditures, and this has some costs, the same costs that the governments try to avoid in the first place by financing public expenditure through indebtedness.

Jacob Richter said...

Free access to employment in any enterprise of choice on the part of job-seekers? What literature covers this, if you don't mind my asking?

Forgive me for having been a bit snippy in my earlier comment on Guy Standing. It's just that I've become quite enthusiastic about the Public Employer of Last Resort, especially in debates against Universal Basic Income.

I highly appreciate the fact that you are indeed aware of Minsky's ELR, unlike Krugman and most other "full employment" economists.

D. Mario Nuti said...

Free access to employment in any enterprise of choice on the part of job-seekers? See Theodor Hertzka (b. Budapest 1845-d. Wiesbaden 1924), Freiland, ein soziales Zukunftsbild (Leipzig, 1890). I believe it can be downloaded from the Gutenberg Project website.

chilosi said...

Let me do some advertisement for myself: if you wish to know everything about the economics of free access to employment look at my paper “The Lange-Breit Model, the Right to Employment and the Outside Option.” Zdzislaw Sadowski (ed.), Oskar Lange a wspolczesnosc, Warszawa: Wydawnictwo Polskiego Towarzystwa Ekonomicznego, 2005, pp.157-169 (http://www.dse.ec.unipi.it/persone/docenti/Chilosi/brei%20lange%20and%20the%20ouside%20option.pdf).

Jacob Richter said...

Thanks for the paper! Are you a market-socialist of some sort?

chilosi said...

I have worked extensively on socialism in general and on market socialism in particular. If you go to my web page http://www.dse.ec.unipi.it/persone/docenti/Chilosi/main-research.htm
you can donwload other papers on market socialism that I hope could be of interest to you.