the recessive attitude of emu policies: reflections on the italian experience within the last ten...

THE RECESSIVE ATTITUDE OF EMU POLICIES: REFLECTIONS ON

THE ITALIAN EXPERIENCE WITHIN THE LAST TEN YEARS

by Rosaria Rita Canale and Oreste Napolitano

Universitià di Napoli “Parthenope” Dipartimento di Studi Economici “Salvatore Vinci”

2

Aim of the paper: To show, through the measurement of the effect of

public expenditure and interest rate setting on national income in Italy from 1998 to 2008 that,

A) government expenditure had a central role in determining the growth rate of GDP

B) before the crisis monetary policies had real effects, while during financial crisis it was unable to inject money in the market

To underline the weakness and the recessive attitudes of European policy framework both on the side of fiscal and monetary policy

3

European economic policy framework Theoretical foundations I

Monetary policy (NCM)Stream of thought I: 1.time inconsistency (Kydland e Prescott 1977) 2.“only unanticipated money matters” (Lucas 1972,

Sargent and Wallace 1975) 3.destabilizing effects on expectationsStream of thought II (NKM):The efficacy depends on:1.labour, credit or goods market imperfections (Blanchard

2008)2.Unanticipated price changes (Posen 2008)

4

European economic policy framework Theoretical foundations II

Fiscal policy

Public expenditure creates expectations of grater future taxation and public debt (Barro 1974)

Crowding-out effect Inflationary effect Politicians subordinate decisions to consensus

mechanism (Buchanan and Tullok 1962, Solow 2005)

5

EMU Macroeconomics fundamentals

1. Short period policies are not desirable because of their effects on inflation;

2. Inflation is a monetary phenomenon;

3. GDP and unemployment fluctuate around their long run equilibrium level. This last one does not depend on active fiscal and monetary policies;

These principles represent the theoretical underpinnings of Maastricht Treaty and Stability and Growth pact, whose main objective is the avoidance of any monetary disturbance for the convergence toward the natural unemployment rate (Arestis and Sawyer 2003 and Arestis, McCauley and Sawyer 2001)

6

Theoretical limits of “macroeconomic consensus”

1. The reference interest rate is fixed by the Central Bank (Canale et alii 2009)

2. Money is not neutral especially in condition of unemployment

3. A behavioural equation rather than an identity describes the process of GDP formation (see Krugman 2009 vs Cochrane 2009 and Fama 2009)

4. Wealth effect on public debt

7

Empirical evidence does not give unequivocal results

Monetary policy:Effects on income and prices in imperfect markets. Cochrane (1998) Clarida, Gali and Gertler (1999 and 2000) and Galì and Gertler (2007) The CB cannot fix negative interest rates so that it is not always possible to make output to converge just taking after inflation. Benhabib, Schmitt-Grohé e Uribe (1999) Fiscal Policy: Problems of variables identifications (Perotti 2007) Blanchard and Perotti (2002) The multiplyer is positive. Mihov (2001) Monacelli and Gali (2005) Fatas and Mihov (2009) Alesina, Campante and Tabellini (2007)Ricardian equivalence is not univocally demonstrated Hemming, Kell e Mahfouz, (2002)

The policy efficacy depends on the joint action of monetary and fiscal policy See Canale (2009) and Canale et al (2008) vs Giavazzi and Pagano (1990) etc Consolidated empirical literature uses VAR technique to evaluates the response to shocks of e.g. aggregate equilibrium income, and therefore assumes that an equilibrium value already exists;We use OLS technique to capture the measure of contribution to income of the independent variables

8

Macroeconomic performance of fiscal and monetary policy in Italy from 1992 to 1998

-20

-15

-10

-5

0

5

10

15

20

1992q01 1993q01 1994q01 1995q01 1996q01 1997q01 1998q01

gdpgrow th inflazione dep_rate Deficit

Economic policies with the aim of joining the EMU

• Interest and inflation rates convergence

• Public deficit reduction strategy

• No great effects on GDP growth (0,6%)

9

Macroeconomic performance of fiscal and monetary policy in Italy 1999-2008

-6

-4

-2

0

2

4

6

gdpgrowth

inflazione

dep_rate

Deficit/GDP

The 1999-2001 period: growth and improvements of public accounts

the 2001-2008 period: a slow down of growth and progressive deterioration of public accounts

10

We use a model according to which equilibrium income is determined by its components not simultaneously.

Therefore it assumes the following form:

(1)

Where (t-i) is the index of lagged variables influencing GDPThe equation (1) can be re-written as:

(2)

In order to examine the influence on income of fiscal and monetary policy and avoid problems of autocorrelations we estimate one variable at a time: :

( )t t iY f Z

0 1 1, 2 2, 3 3, ,.......t t i t i t i n n t iY z z z z

11,

t

t i

Y

z

22,

t

t i

Y

z

,

tn

n t i

Y

z

or or …………….

Empirical analysis I: the model

11

Empirical analysis I – results

The first estimate represents the effects of public expenditure (Tex) on GDP (Table 2) .Empirics shows that public expenditure had a positive correlation with nominal GDP from 1998 to 2008

Table 2. Public expenditure effects on nominal GDP Dependent Variable: GDP1 (nominal index of GDP)

Variable Coefficient t-statistic

C 76.18828*** 7.038606

Tex(-1) 0.491754*** 5.899669

R2 0.484723Obs.: 39, Sample (adjusted): 1999:02; 2008:4D-W stat: 1.400407; AIC 7.566932; F-stat 34.80610***

12

Empirical analysis I –results

The second estimate shows the effects of public expenditure (Tex) on real GDP (table 3).

Empirics shows that from 1998 to 2008 public expenditure had a positive correlation with real GDP

Table 3. Public expenditure effects on real GDP Dependent Variable: GDP2 (real index of GDP)

Variable Coefficient t-statistic

C 106.0451*** 28.53820

Tex(-1) 0.163956*** 5.729890

R2 0.470514Obs.: 39, Sample (adjusted): 1999:02; 2008:4D-W stat: 1.3988210; AIC 5.428578; F stat 32.83164***

13

Empirical analysis I – results

Results do not have a great change if we consider jointly the effects of total expenses (Tex) and total revenues (rev) on GDP

Tables 4 describes the regression results both on nominal GDP index

Table 4. Joint effects of public expenditure ant revenues on nominal GDP Dependent Variable: GDP1 (nominal index of GDP)

Variable Coefficient t-statistic

C 71.36942*** 6.310181

Tex(-1) 0.321952*** 3.514355

Rev(-3) 0.198156*** 2.704307

R2 00.530097.797115; Adjusted R2 0.502455Obs.: 37; Sample (adjusted): 1999:04; 2008:4D-W stat: 1.969720; AIC 7.400598; F stat 19.17764***

14

Empirical analysis I – results

Tables 5 describes the regression results taking into account the real GDP index

Table 5. Joint effects of expenditure and revenues on real GDP Dependent Variable: GDP2 (real index of GDP)

Variable Coefficient t-statistic

C 105.6890 *** 27.75564

Tex(-1) 0.104996 *** 3.404221

Rev(-3) 0.059835 *** 2.425457

R2 0.498782Adjusted R2 0.469298Obs.: 36; Sample (adjusted): 2000:01; 2008:4D-W stat 1.835883; AIC 5.223311; F stat 616.91736***

15

Table 6 describes the real effects of repurchase rate setting. As we can see the coefficient is negative and significant.

Table 6. Real effect of monetary policy strategy IDependent Variable: GDP2 (real index of GDP)

Variable Coefficient t-statistic

C 10.62128*** 3.430827

GDP2(-1) 0.924243*** 38.34049

Rep_rate(-2) -0.317137** -2.338799

R2 0.977134; Adjusted R2 0.975827Obs.: 38; Sample (adjusted): 1999:03 2008:4D-W stat 1.936779; AIC 2.234471; F stat 747.8319***

Empirical analysis I – results

16

Results do not change if we consider the EONIA rate instead of repurchase rate, because of the direct proportionality between the two rates

Table 7. Real effect of monetary policy strategy IIDependent Variable: GDP2 (real index of GDP)

Variable Coefficient t-statistic

C 10.89945*** 3.492447

GDP2(-1) 0.924399*** 38.31560

Eonia(-2) -0.303109** -2.321781

R2 0.977089; Adjusted R2 0.975780Obs.: 38; Sample (adjusted): 1999:03 2008:4D-W stat 1.957125; AIC 2.236432; F stat 746.3319***

Empirical analysis I – results

17

Interesting results come out of the empirical analysis of the relation between debt and GDP. Coefficient is positive and significant

Table 8. Real effects of public debtDependent Variable: GDP2 (real index of GDP)

Variable Coefficient t-statistic

C 19.96988*** 7.230646

GDP2(-1) 0.772619*** 17.88903

Debt(-1) 0.078703*** 2.755561

R2 0.9839600; Adjusted R20.983158Obs.: 43; Sample (adjusted): 1998:02 2008:4D-W stat 1.634168; AIC 2.482092; F stat 1226.903***

Empirical analysis I – results

18

Comments on results

The positive relation between government expenditure and GDP shows that in the years from 1998 to 2008 fiscal policy in Italy influenced growth both in nominal and real terms (Tables 2, 3, 4, 5)

The negative relation between the repurchase rate (or EONIA) and real income brings us to conclude that, because of the direct proportionality with all other rates in the market, monetary policy had in the years considered a negative effect on GDP (Tables 6 and 7)

Despite mainstream literature assertions about the Ricardian equivalence and the negative effects of public debt, empirical evidence shows that public debt had same sign effects on real GDP (table 8).

19

Empirical Analysis II – The Kalman filterWe use the Kalman filter methodology to evaluate how the coefficients of the main variables influencing GDP have been varying through time.Assuming that βi,t was determined by an autoregressive process AR(n), we use the following model with changing parameters :

Where yt is the GDP, μit is a identified by a “white noise” process, and the vector of coefficients βi,t is “random walk”.

t 0,t 1,t t ty =β +β Z +μ

20

Empirical Analysis II – The Kalman filter results

Results are presented in table 9 and in figures 5 and 6. Coefficients have a sign consistent with the OLS regression and are

significant. The path of coefficient βi,t (figures 5 and 6) appear to add interesting results about dynamic effects of monetary and fiscal policies in that period.

Table 9. The Kalman estimations

(rep_rate) 1,t 2,t

AIC=7.03Schwarz=7.07Obs. 38(Q)

127.03** (76.59)[ 0.000]

-0.2865**(-11.29)[ 0.003]

(Govern. Expenditure)

AIC=8.61Schwarz=8.65Obs. 39 (Q)

73.81**(6.687 )[ 0.000]

0.50111**(6.054)[ 0.000]

21

The Kalman filter and monetary policy

It is interesting to note that the coefficient of the discount rate changed few years after the EURO (figure 5)

The second relevant change in the discount rate coefficient occurs around the year 2006. Figure 5 shows that in that period there is an inversion of the path. The opposite effect of interest rates movements on GDP reduces and, at a time of financial crises, it approximates to zero.

Around the year 2008 happened a kind of liquidity trap, testifying the fact that the interest rate lowering policy was not able to inject money in the market during the crisisFigure 5. Monetary policy coefficient behaviour

22

The Kalman filter and fiscal policy On contrary public expenditure coefficient is always positive testifying the fact that government expenditure had a great part in determining the GDP in those years. The coefficient of the public expenditure is positive and ever increasing till the end of the period

Figure 6. Fiscal policy coefficient behaviour

23

Conclusions In Italy in the period from 1998 to 2008

1) Public expenditure had same sign effects on GDP2) Debt did not have negative effects3) Monetary policy had real effects4) The effects of fiscal policy have been growing through time5) Monetary policy reduced its influence on GDP during the crisis

Generalizing the Italian results: Because of the lack of a shared fiscal policy and of an inflation

targeting monetary policy strategy, the economic policy structure in

EMU:

A) Is unable to contrast current economic crisis

B) Hardly weakens the existence of the monetary union as a whole

(Krugman, 2009, Wray 2003)