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We've seen lots of ideas on how to run a fiscal union. Eurobonds, partial pooling of sovereign debt up to the Maastricht debt limit, an agressively financed EIB, ECB monetizing deficits, outright fiscal transfers, and so on.

What they all have in common is that they've all been shot down. A big reason for this seems to be that people consider them unfair: it looks like the frugal people who've kept their houses in order are going to have to pay for the lazy wastrels. Even if the real macro story is a bit different from this (to say the least), this is an incredibly powerful narrative, which means it's important to figure out some way to get around it.

So I've figured out another mechanism for fiscal union - Migeru didn't like it much, but I'd like to hear your opinions. Keep in mind that the idea is not to create a perfect fiscal solution, but something that works good enough to actually be implemented and transform the EMU from a mass unemployment-producing machine into something reasonably functional.

The idea is that we create something we call the European Fiscal Mechanism, the EFM. This is an independent organization which is tasked with estimating the aggregate European output gap. If it detects such an output gap, it injects fiscal assets (i.e. cash) into the state budgets of all Euro member nations, in some way which is seen as fair. Say, a country which makes up 20% of the Euro economy gets 20% of the cash, no matter if it has an actual output gap or not.

If the crisis, like the current one, is a result of current account imbalances, spending in current account surplus nations without output gaps will help too, as it will push inflation in those countries and help get the unit labor costs in line with those in the countries with current account deficits.

The money is only disbursed from the EFM to the member state if it is spent on something. Spending it on paying down state debt does not qualify as spending in this view, but spending it on infrastructure, social programs, tax cuts and so on does.

The EFM raises money for disbursement by selling long-dated bonds into the market. All its bonds are guaranteed by the ECB. Another identical option would be direct borrowing from the ECB, but this would set off even more red lights, so we shall in this way "sanctify the money through the bid/ask spread of investment banks".

The EFM will gradually and over time manage its debt by refinancing its current bonds with new bonds when the old ones mature, and also if needed have priority access to a certain fraction of the annual the EU budget, i.e. the money which is extracted from the member states via the membership fee. This will also have the added bonus of forcing the EU to cut useless and wasteful spending programs, which is sure to be both useful and popular.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Tue Jul 22nd, 2014 at 06:03:57 PM EST
[ Parent ]
The frugal people who've kept their houses in order is a good cover for rentiers, financial sharks. The output gap is alomost a derivative of the rentier power gap.

Nothing wrong about getting return on capital... in normal times. But when debt entitlements are sacred regardless realistic  social-economic conditions, this is basically an end of the free market and democracy.

by das monde on Tue Jul 22nd, 2014 at 10:11:10 PM EST
[ Parent ]
How to finance your EMF?

I think such a mechanism should be financed through a Europe wide tax on capital, call it the Pickety tax.

by rz on Wed Jul 23rd, 2014 at 01:41:32 AM EST
[ Parent ]
I don't think that would work very well. First, because the effect might be slight, as we would reduce spending by taxing people. Sure, the reduction in spending from increased taxation would be smaller than the increase in spending from increased government spending (as not all the taxed wealth would be spent in the first case - some of it would have been saved). We would still get a net increase in spending, but borrowing would be even better from that point of view.

And it would look a bit silly if we increased taxes and doled out the money to the member states just to see them cut the same taxes with the same money. Then we're not really getting any traction. We could of course say that the new money couldn't be used for tax cuts, but I think that would make it even harder to get a program like this down the throat of the member states.

Also, I don't think we want to make this a leftist "soak the rich"-thing, because then it would never get support from the center-right, which is a prerequisite for any realistic solution. We can soak the rich later, but our first priority one must be to stop mass unemployment in Europe.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Wed Jul 23rd, 2014 at 06:04:28 AM EST
[ Parent ]
Don't estimate "output gaps." Such estimates always, always, always underestimate the true need for fiscal expansion. (Both for structural, methodological reasons and because they are trivial to manipulate for partisan political advantage, and those who have access to make such manipulations are normally biased toward deflation.)

Simply pay out a percentage of EU nominal GDP per capita equal to the higher of the EU overall unemployment rate or the simple, unweighted average of the national unemployment rates.

It should be a wholly separate facility from the rest of the EU budget, so as to protect it from partisan tampering and the temptation to divert the funds for other purposes.

Your proposed funding scheme would have made Charles Ponzi balk, but then again the rules it is designed to circumvent are the kind of transparently bad-faith nonsense that invites this sort of Rube Goldberg solutions.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Jul 23rd, 2014 at 02:36:36 AM EST
[ Parent ]
JakeS:
Simply pay out a percentage of EU nominal GDP per capita equal to the higher of the EU overall unemployment rate or the simple, unweighted average of the national unemployment rates.

Since the unemployment rate is eminently manipulable, use the employment rate to inversely determine the percentage.

by afew (afew(a in a circle)eurotrib_dot_com) on Wed Jul 23rd, 2014 at 03:08:23 AM EST
[ Parent ]
When it comes to measuring output gaps, that is as you say, quite easy to manipulate, and some kind of simplified solution might be a good idea. It's better with too much fiscal support from the EFM than too little, as the ECB can far more easily adjust its monetary policy to deal with overheating than recession, due to the existence of the zero lower bound.

I think linking the funding of the EFM to the EU budget in some indirect way would help get it populist/eurosceptic support, which is sorely needed. You could avoid partisan problems by just saying that the EFM has the right to take XX% of the EU budget every year if it feels like. Obviously the EFM needs to be independent like the ECB, except staffed by non-crazy people. Ideally, people should think of it as an equal to the ECB.

And yes, it sure is a Rube Goldberg-device, but we can't let the perfect become the enemy of the good. Remember, every day with 25% unemployment in Spain is a total disaster. Every single day.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Wed Jul 23rd, 2014 at 05:57:40 AM EST
[ Parent ]
The idea is that we create something we call the European Fiscal Mechanism, the EFM. This is an independent organization which is tasked with estimating the aggregate European output gap. If it detects such an output gap, it injects fiscal assets (i.e. cash) into the state budgets of all Euro member nations, in some way which is seen as fair. Say, a country which makes up 20% of the Euro economy gets 20% of the cash, no matter if it has an actual output gap or not.
Okay... EU Balks at Changing Deficit Rule to Ease Austerity (WSJ, September 25, 2013)
The change was approved by technical experts at a meeting last week and was expected to be supported at a Tuesday meeting of more senior officials in Brussels. But an article published in The Wall Street Journal about last week's decision generated concern in some national capitals about its effects on budget policies, an EU official said.

...

The change involves a highly technical methodology that the European Commission, the European Union's executive arm, uses to calculate the "structural deficit," which is the actual budget deficit adjusted for the strength of the economy. The commission uses the structural deficit to determine how much austerity governments will need to undertake to meet EU budget targets.

...

Europe's current calculations about how much of the deficit is structural and how much is caused by the downturn in the business cycle assume much of the budget deficits seen in the bloc's weakest economies are built-in, meaning they will persist even after the economy has returned to full strength. If a deficit is structural, rather than cyclical, more austerity measures--spending cuts or higher taxes--are required.



A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Wed Jul 23rd, 2014 at 05:30:01 AM EST
[ Parent ]
Europe's current calculations about how much of the deficit is structural and how much is caused by the downturn in the business cycle assume much of the budget deficits seen in the bloc's weakest economies are built-in, meaning they will persist even after the economy has returned to full strength. If a deficit is structural, rather than cyclical, more austerity measures--spending cuts or higher taxes--are required.

I am trying to figure out what formal school of economics would lead to this conclusion. Austrian? The prescription seems to be 'if the patient is ill, amputate. Still not well? More Amputation.' The economics of cannibalism.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Jul 25th, 2014 at 10:16:59 PM EST
[ Parent ]
This is mainstream neoclassical NAIRU bullshit. Read this revised methodology for calculating output gaps [PDF] and weep.

Also, Noahpinion has a guest post on How important was the "structural balance" screw-up in driving European austerity? (October 05, 2013) describing what's wrong with the European Commission's econometrics.

The European Commission uses a production function methodology for calculating potential growth rates and output gaps (see here). It features a simple Cobb Douglas specification where potential output depends on TFP and a combination of factor inputs (potential labor and capital). Importantly for what follows, potential labor input is calculated as:

Working age Population x Participation rate x Average hours worked x (1 - NAWRU)

It's important to focus on potential labor input since the bulk of the revisions applied between 2008 and 2010 to potential GDP arose because of revisions to labor input.

And note the use of NAWRU rather than NAIRU. If you use NAIRU (non-accelerating-inflation rate of unemployment) you're using unemployment as a policy lever to achieve an inflation policy target. But if you use NAWRU (non-accelerating-wages rate of unemployment) you're using deliverately using unemployment to depress wages, but hiding that under a supposedly objective econometric model.

It really is criminal.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Sat Jul 26th, 2014 at 12:07:58 AM EST
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Then the intellectual heritage would be  Keynesian Synthesis, per Samuelson and Phillips, but grossly perverted by Monetarists and further perverted by compromizing with Keynes rejectionists from the original version of Neo-Classical Economics.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Jul 26th, 2014 at 11:38:00 AM EST
[ Parent ]

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