ByBrunello Rosa

One year before the beginning of the global financial crisis. This is certainly a welcome development. At the same time, the major policy institutions, market participants and independent research houses (including RGE), expect Italy’s GDP in 2015 to grow only by 0.7% (median forecast), around half the pace of the Eurozone as a whole.

On the one hand, one could argue that 0.7% is already above Italy’s current (post-crisis) growth potential, which RGE estimates to be around 0.4% (vs 1.0% pre-crisis), and therefore enough to start absorbing part of the spare capacity in the economy, and potentially reduce the high unemployment rate (together with some of the recently-introduced reforms of the labour market and the three-year tax break for new hires).

On the other hand, it is certainly true that the Italian government cannot be satisfied with these low growth rates, especially when considering that they are likely to be the result of the combined effects of exogenous factors such as lower interest rates and lower EUR exchange rates (favoured by the ECB’s accommodative monetary policy stance), lower oil prices and the (marginally) increased fiscal flexibility granted by the EU Commission in January 2015, which allowed Italy to temporarily deviate from its Medium-Term Objective (MTO) in the light of exceptional economic circumstances.

In 2016, Italy is hoping to be granted again the possibility of temporarily deviating from the MTO on the back of the ambitious reform plan implemented by the government. This could help Italy achieve a slightly higher growth rate than in 2015, perhaps north of 1% (net of the positive boost to the economy potentially deriving from the extraordinary Jubilee). But more support is needed to allow the Italian economy to recover faster, thus preventing the parallel processes of de-industrialization and hysteresis from becoming entrenched and ultimately intractable.

The Much Needed Fiscal Support To Aggregate Demand

I believe that the missing piece of the jigsaw in the European policy response to the global financial crisis has been the fiscal support to aggregate demand. True, the European rules on fiscal discipline mandate Italy’s fiscal deficit to remain below 3%, and its structural fiscal balance to converge towards -0.5%. But more can be done without infringing the rules. In particular, there is a better way of using the fiscal space the EU Commission has granted to Italy and other deficit countries in January 2015.

I want to refer in particular to the tax credit/bonus promoted by Renzi’s government in 2014 (the so-called “€80/month” for low earners) and possibly to the further tax cuts Prime Minister Renzi has proposed for the 2016-2018 period.

For the sake of simplicity, I will refer to the €80/month measure proposed in 2014, reiterated and expected to become “structural” in 2015, when the € 10 billion cost of the measure can be reasonably expected to be covered by the savings to public expenditure deriving from the spending review carried out by the government (but the same argument applies to any tax cut financed either by equal spending cuts, or by increases in the fiscal deficit).

In 2014 and 2015, the measure was implemented by crediting with additional €80/month the payslip of selected workers earning between € 8.000 and €24-26.000/year (gross). The people entitled to the “bonus” could choose what to do with the additional credited amount.

It is hard to know whether the measure was successful or not, as Italy’s GDP in 2014 fell by 0.4%, but could have fallen more in the absence of the measure. There is something we can say almost for sure, though. The measure was not as successful as could have been, if it had been implemented differently.

“Fiscal” Money Needs To Be Spent, Not Saved, To Boost GDP Growth

Key to the success of a measure of fiscal support is that the additional money is spent, hence entering the economic circuit, rather than saved. What we can almost certainly say is that the additional € 6 billion provided to around 11 million people in 2014 (and € 10 billion in 2015) were partly spent, partly used to pay (in some cases higher) taxes and partly saved. This has diminished the positive impact of the measure.

Let’s abstract from the part of the bonus spent in (perhaps higher) taxes, which effectively reduced the effectiveness of the measure to almost zero, and let’s focus instead on the component that was saved rather than spent. It is quite likely that this component was pretty large, if one inferred from the tepid welcome gathered by another measure meant at increasing households’ disposable income, i.e. the possibility of start receiving part of the severance package (TFR) as part of the monthly salary in 2015.

It could be possible to argue that, from a broader perspective, increasing household savings helps the national economy as it contributes to repair the balance sheet of indebted families or to re-constitute the stock of savings depleted in the last few years. But increasing savings will hardly boost consumption, and therefore GDP growth. For that to happen, the extra money provided with the €80/month bonus or future tax cuts needs to be spent. How to ensure that?

A “Fiscal Debit Card” With An Expiry Date

Now that the names of the people entitled to receive the bonus (or future tax cuts) are known, it would be much more effective to put the same amount of money (effectively € 1000/year) into a “fiscal debit card” (“carta pre-pagata fiscale”) with an expiry date, for example – for the fiscal year 2016 – 31/12/2016. By that day, either the money is spent, or is lost (use it or lose it). The individuals can chose how to spend it, but not whether to spend it or not[1].

Given the novelty of the measure introduced in April 2014, the fact that the EU Commission hadn’t yet approved the additional flexibility granted in January 2015 and that the ECB was not buying government bonds, one can understand why the €80/month measure was implemented as it was. But for the next few years, it would be much more effective to proceed as suggested above. Also because the adoption of a “fiscal card” allows plenty of flexibility for the reiteration of the measure in coming years.

For example, in 2017 the government could decide to reduce the amount with which any card is “charged” (for example from € 1000 to € 800 a year), if the measure were to become too onerous. Or a different set of recipients could be selected (for example, to include pensioners and/or “incapienti”). Or the government could choose that any amount spent from the card must be matched by an equal amount spent from “private” money, to start putting savings in circulation.

Macroeconomic Effects: A Boost To Growth, Inflation And Fiscal Revenues

If this “fiscal debit card” were to be introduced, the government would ensure that the money given to households could enter in circulation, the usual multiplier effects of the economy could kick in, and additional tax revenues (from VAT and income taxes) would be generated, thus partly financing the cost of the operation. With no cash involved, fiscal revenues are meant to increase at every use of the card.

This would also justify the fact that the coverage of this expansionary fiscal operation could initially come from a higher deficit, rather than an equivalent cut in spending, especially in a period when the central bank (ECB) is buying government bonds, thus providing a tremendous backstop to the domestic sovereign bond market. In such circumstances, in fact, the combination of increased public spending (via households) – financed by increased fiscal deficit, and the central bank’s de-facto debt-monetization is the optimal policy mix to exit the recession and subsequent stagnation (as proven by the U.S. and UK experiences). Any inflationary impulse deriving from this mix of expansionary policies could only be welcome, in a period of persistent low-flation/deflation[2].

In conclusion, by simply changing the implementation method of an existing policy, already approved by the EU, the government could boost growth and inflation, and ultimately unemployment, while remaining below the 3% fiscal deficit/GDP ratio and avoiding the opening of an excessive deficit procedure. The increase in nominal GDP would then allow the government to also respect the promise of reducing the high debt/GDP ratio over time.