The Italian general elections of March 4, 2018 have produced an improbable coalition government between two upstart populist parties: left-Eurosceptic-nationalist Movimento 5 Stelle (Five Star Movement) and the right-Eurosceptic-nationalist Lega (League). The coalition partners agree on greater public spending and, at the same time, on tax cuts that would reduce revenue. How then to pay for the additional spending? Italy is already highly indebted. Its public debt stands at 133 percent of GDP, highest in the Eurozone apart from Greece, and well above the EU’s average of 87 percent. Its sovereign bonds carry a high default risk premium. Today, the yield on Italian 10-year bonds stands at 291 basis points above the yield on 10-year German bunds, up from a spread in the 130-40 range during the months before the election.
If tax revenue and debt cannot practically be increased, the remaining fiscal option—for a country with its own fiat currency—is printing base money. But Italy is part of the Eurozone, and only the ECB can create base-money euros. A group of four Italian economists (Biagio Bossone, Marco Cattaneo, Massimo Costa, and Stefano Sylos Labini), correctly noting that “budget constraints and a lack of monetary sovereignty have tied policymakers’ hands,” and regarding this as a bad thing, have proposed in a series of publications that Italy should introduce a new domestic quasi-money, a kind of parallel currency that they call “fiscal money.” Similar proposals have been made by Yanis Varoufakis, the former Greek finance minister, and by Joseph Stiglitz, the prominent American economist. Italy’s coalition government is reportedly considering these proposals seriously.
Under the Bossone et al. proposal, the Italian government would issue euro-denominated bearer “tax rebate certificates” (TRCs). The government would pledge to accept these at face value in “future payments to the state (taxes, duties, social contributions, and so forth).” The certificates in that sense would be “redeemable at a later date – say, two years after issuance.” If non-interest-bearing, they would trade at a discounted value. But if interest were paid to keep the certificates always at par, and the payment system accordingly accepted them as the equivalent of base-money euros, the certificates would be additional spendable money in the public’s hands. “As a result,” they argue, “Italy’s output gap — that is, the difference between potential and actual GDP — would close.” Thus they claim that “properly designed, such a system could substantially boost economic output and public revenues at little to no cost.”
Remarkable claims. Bossone et al. have recently argued that their “fiscal money” program would not violate ECB rules. But there is a more basic question: would it actually work to boost real GDP sustainably by shrinking unemployment and excess capacity? On critical examination, the answer is no. The proposal is based on wishful thinking.
To provide empirical context, note that estimated slack in the Italian economy is already shrinking. The OECD estimate of Italy’s output gap (the percentage by which real GDP falls short of estimated full-employment or “potential” GDP) was large—greater than 5 percent—for 2014, the year when Bossone et al. first floated their proposal. Among the major Eurozone economies, only Greece, Spain, and Portugal had larger gaps; France had a gap half as large, while Germany was above its estimated potential GDP. For 2018, however, Italy’s estimated output gap is under 0.5 percent. For 2019 the OECD projects that actual GDP will exceed full-employment GDP.
Theoretically (as famously argued by Leland Yeager and by Robert Clower and Axel Leijonhufvud), in a world of sticky prices and wages a depressed level of real output can be due to an unsatisfied excess demand for money, which logically corresponds to an aggregate excess supply (unsold inventories) of other goods including labor. People building up their real money balances will do so by buying fewer goods at current prices and offering more labor at current wages. But is that the cause depressed output in Italy today? Yeager’s “cash-balance interpretation of depression” assumes an economy with its own money, domestically fixed in quantity, so that an excess demand for money can be satisfied only by a drawn-out process of falling prices and wages that raises real balances.
But Italy today does not have its own money. It is a part of a much larger monetary area, the Eurozone. (For one indication of Italy’s share of the euro economy, Italian banks hold 14.7% of euro deposits.) The European Central Bank through tight monetary policy can create an excess demand for money in the entire Eurozone, in which case Italy suffers equally with other Eurozone countries, but it cannot create an excess demand for money specifically in Italy. A specifically Italian excess demand for money can arise if Italians increase their demand for money balances relative to other Eurozone residents, but in that case euros can and will flow in from the rest of the Eurozone (corresponding to Italians more eagerly selling goods or borrowing) to satisfy that demand.
Because Italy’s small output gap in 2018 therefore cannot be plausibly attributed to an unsatisfied excess demand for money, an expansion of the domestic money stock through the creation of “fiscal money” is not an appropriate remedy.
If not due to an excess demand for money, what is the cause of Italy’s lingering output gap? I don’t know, but I would look for real factors. Likely candidates are labor-market inflexibility in the face of real shocks, and the reluctance of investors to put financial or real capital into a country with serious fiscal problems (hence a serious risk of new taxes or higher tax rates soon) and a non-negligible threat of leaving the euro.
The flip side of flowing into Italy from the rest of the Eurozone, to satisfy Italian money demand, is that any excess money in Italy will flow out. If Italians already hold the quantity of euro balances they desire, then the creation of “fiscal money” would not increase Italy’s money stock except transitorily. Supposing that Italians treat new “fiscal money” as the domestic equivalent of euros, the addition to their money balances would result in holdings greater than desired at current euro prices and interest rates. In restoring their desired portfolio shares (spending off excess balances) they would send euros abroad (by assumption, the domestic quasi-money would not be accepted abroad) in purchases of imported goods and financial assets.
It isn’t clear, however, that the public would actually regard “fiscal money” as the equivalent of base-money euros added to the circulation. Unlike fiat base money, TRCs are not a net asset. They come with corresponding debts, the government’s obligation to accept them in lieu of euros for taxes (say) two years after issue. There is no reason for taxpayers to think themselves richer for having more TRCs in their wallets given that they will need to pay future taxes (equivalent in present value) to service and retire them.