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Fiscal Space and Financial
Stability: A Differential
Analysis
The U.S. vs. The Eurozone
Stephanie Kelton, Ph.D.
FIELDS-INET
November 1, 2013
The Orthodox Perspective:
A One-Size Fits All Attempt to
Define “Fiscal Space”
Government Budget Constraint
G + iB = T + ΔB + ΔM
Assumptions:

Gov’t spending is “financed” by T + ΔB
“Financing” gov’t spending via ΔM is inflationary

“Constraint” is thus to select G such that ΔM = 0
Intertemporal Budget Constraint
Blanchard et al. 1990
ΔB = G – T + iB

(note no ΔM)

Rewriting in real terms and as % of real GDP:
Δb = g - t + (r – Θ)b

For any time, n, in the future . . .
bN = b0(1+r-Θ)N + Σ(g-t)(1+r-Θ)N-k
Taking present value . . .
PV bN = b0 + PV projected Σ(g-t)
Also, since

then

PV bN = bN / (1+r-Θ)N,
Limit PV bN as N→∞ = 0

Thus, for fiscal sustainability,

0 = b0 + PV projected Σ(g-t)

-b0 = PV projected Σ(g-t)
In (Other) Words
• The cumulative discounted present value
of the expected future surpluses must be
equal to the current national debt
outstanding

• If that condition is not satisfied, then the
debt is not “sustainable”
• Government would have to eventually
repudiate its debt, either by an outright
default or through the use of inflation
Resulting in Claims Like This
“Fiscal space”
(shaded area) runs
out as government
approaches the
“debt limit”
Bad Assumptions Are Driving the Model
“California’s bond rating has sunk to a level just above junk
status . . . . California is teaching the U.S. a valuable lesson
about the connection between fiscal policy and financial
markets.”
“Unless action is taken very soon to reform the main U.S.
benefit programmes, Washington may have to grapple with the
same crisis currently preoccupying Sacramento.”
“Unresolved, the situation could cause U.S. Treasury yields to
rise sharply, wreaking havoc on the national economy.”
Gokhale and Smetters, Financial Times (9/7/03)
Isn’t that What Happened in
Greece?
What’s Different About the US?
• In modern (or sovereign money) systems
operating with flexible exchange rates, interest
rates on the national debt are a matter of
political economy
• “This has significant implications for the
appropriate “mix” of monetary and fiscal policies,
particularly if full employment and financial
stability are considered fundamental goals of
macroeconomic policy.”
~ Scott Fullwiler, 2006
Fullwiler on “Fiscal
Sustainability”
• “In short, the orthodox
concept of fiscal
sustainability is flawed
due to its assumption
that a key variable –
the interest rate paid on
the national debt – is
set in private financial
markets as in the
orthodox loanable
funds framework”
The MMT Perspective
The Financial Balance
Approach
to Macro Stability
• Understood by J.M. Keynes and early Keynesians
like Nicholas Kaldor, Abba Lerner, and Joan
Robinson
• “Lost in the headlong rush over the past three
decades of mainstream macroeconomics to
become a special branch of microeconomics,
which itself appears to have become a special
branch of applied calculus in some sort of rather
twisted physics envy.” (Parenteau, 2009)
“Without an expansionary
fiscal policy, real output cannot
grow for long.”
~ Wynne Godley, 2000
Why?
• Because the US runs persistent current
account deficits
• This has important implications for financial
stability
• Godley relied on the sector balance framework
to undertake his analyses

• Showed that countries with current account
deficits would need to run budget deficits
most of the time
Why Does it Have to be
Government?
• The US household sector cannot net save in nominal
terms (spend less money than it earns) unless some other
sector (or combination of sectors) is willing and able to
spend more money than it earns.
• It can be the government, the business, or the foreign
sector or some mix of the three
• But keep in mind, of the three, a government with a
sovereign currency (not convertible into fixed quantities of a
commodity or another currency on demand) and no debt
denominated in foreign currencies is the only one of those
three that cannot go bankrupt and cannot default on its
debt while continuously deficit spending – unless it chooses
to default for some odd political reason
Are Deficits
“Responsible”?
Fiscal Space and Financial Stability: A Differential Analysis
Fiscal Space and Financial Stability: A Differential Analysis
Godley Was a Deficit Owl
He understood that this
sector could only net
save if these sectors (on
balance) spent
more than
their income
In Any Given Period
• The sector balances show whether a
particular part of the economy is:
– Spending more than its income
• Running a Deficit

– Spending less than its income
• Running a Surplus

– Spending just equal to its income
• Balancing its Budget
Rules of the Game
• Three Sectors
– Domestic Private
– Domestic Public
– Foreign (Rest of the World)

• Two Rules
– They can’t all be in surplus
– They can’t all be in deficit
A Simple Accounting Fact

$$$$$
Government
(Public) Sector

$$$$$

Non-Government
Sector
(Households, Firms,
International Trade)

Government Surplus = Non-government Deficit
Government Deficit = Non-government Surplus
In Any Nation
• In practice, at least one sector will always be in
deficit
• Who should it be?

• Godley understood that the private sector
achieved a “habitual state of surplus” and that
private sector deficits were unsustainable
• Expansions driven by a decline in private net
saving were inevitably “followed by a severe
recession”
Beware Swings in Private Net
Saving
The Private Sector Belongs in
Surplus
• “An increase in private debt relative to income
can go on for a long time, but it cannot go on
forever.” (Godley, 2000)
• At some point lenders will run out of creditworthy
borrowers who are willing to spend
• “When that happens asset prices go sideways,
sales soften, jobless claims trend higher, and
economic activity falters” (Wray, 2012)
The Private Sector Cannot Create
Its Own Net Financial Assets
• Assets and liabilities cancel each other out
– Loans create deposits

• Net financial assets must come from outside the
domestic private sector
• Private Sector = Public Sector + Current Account

Surplus
(S – I)

Deficit
(G – T)

Surplus
(X – M)

• If the Public Sector is running a deficit and the current
account is in surplus, the private sector will necessarily be
in surplus
What if the CA is Not in
Surplus?
• Can the private sector still achieve a surplus?
• Yes, but only if the government deficit is bigger
than the current account deficit
EX:

1% = 4% - 3%

• This means that countries with current account
deficits must run even bigger budget deficits (as %
of GDP) in order to keep the private sector in
surplus
Rest of World runs (+)
balance against US
Gov’t runs (+)

Priv. Sect. goes
(-)
What Does this Mean for the
EZ? Surplus (2012Q1, Millions
CA Deficit (2012Q1, Millions
CA
of €)

of €)
Belgium

-1,422

Estonia

-86

Ireland

-1,045

Greece

-4,721

Spain

Germany

+41,068

Netherland
s

+17,454

-14,444

Austria

+3,210

France

-9,626

Slovakia

+648

Italy

-13,067

AVERAGE

+12,659

Cyprus

-718

Malta

-54

Portugal

-1,264

Slovenia

-77

Finland

-1,191

AVERAG
E

-3,976

14 of the EUR-17 run current
account deficits
How Germany Crushed the
Competition
• The rise of German “competitiveness”
began under Chancellor Schroeder in the
early 2000s
• The Hartz Commission and then “Agenda
2010”
– Curtailed the power of labor unions and craft
guilds
– Made it easier for employers to hire/fire at will
– Cut unemployment benefits so that Germans
now receive unemployment benefits for about
Current Account 1996
4.0%

3.0%

2.0%

Percent of GDP

1.0%

0.0%
Portugal

-1.0%

-2.0%

-3.0%

-4.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 1997
4.0%

3.0%

2.0%

1.0%

0.0%
Percent of GDP

Portugal
-1.0%

-2.0%

-3.0%

-4.0%

-5.0%

-6.0%

-7.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 1998
4.0%

2.0%

0.0%

Percent of GDP

Portugal

-2.0%

-4.0%

-6.0%

-8.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 1999
4.0%

2.0%

0.0%

Percent of GDP

Portugal

-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2000
4.0%

2.0%

0.0%

Portugal

Percent of GDP

-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

-12.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2001
4.0%

2.0%

0.0%

Portugal

Percent of GDP

-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

-12.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2002
4.0%

2.0%

0.0%

Percent of GDP

Portugal

-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2003
3.0%

2.0%

1.0%

0.0%
Portugal

Percent of GDP

-1.0%

-2.0%

-3.0%

-4.0%

-5.0%

-6.0%

-7.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2004
6.0%

4.0%

2.0%

0.0%
Percent of GDP

Portugal

-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2005
6.0%

4.0%

2.0%

0.0%

Percent of GDP

Portugal

-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

-12.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2006
8.0%

6.0%

4.0%

2.0%

0.0%
Percent of GDP

Portugal
-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

-12.0%

-14.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2007
10.0%

5.0%

0.0%

Percent of GDP

Portugal

-5.0%

-10.0%

-15.0%

-20.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2008
10.0%

5.0%

0.0%

Percent of GDP

Portugal

-5.0%

-10.0%

-15.0%

-20.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2009
6.0%

4.0%

2.0%

0.0%
Portugal

Percent of GDP

-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

-12.0%

-14.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2010
8.0%

6.0%

4.0%

2.0%

Percent of GDP

0.0%
Portugal
-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

-12.0%

Italy

Ireland

Greece

Spain

Germany

France
Current Account 2011
8.0%

Who won?

6.0%

4.0%

2.0%

Percent of GDP

0.0%
Portugal
-2.0%

-4.0%

-6.0%

-8.0%

-10.0%

-12.0%

Italy

Ireland

Greece

Spain

Germany

France
Fiscal Space with EMU
“[T]he power to issue its own money, to
make drafts on its own central bank, is the
main thing which defines national
independence. If a country gives up or
loses this power, it acquires the status of a
local authority or colony.”
~Wynne Godley, 1992
Fiscal Space and Financial Stability: A Differential Analysis
Permissible Space for Sovereign Issuers
Fiscal Surplus

Current Account
Deficit

Current Account
Surplus

PSB = 0

Fiscal Deficit
May Face Self-Imposed
Constraints
• Debt ceiling
• No overdraft rule
• Fed cannot buy
directly
There are No “Market”
Constraints
“The treasury can always raise money by issuing
securities. The bond vigilantes really have it
backwards. There is always more demand for
treasuries than can be allocated from a limited
supply of new issues in each auction; the winners
in the auctions get to place their funds in the safest
most liquid form of instrument there is for US
dollars; the losers are stuck keeping some of their
funds in banks, with bank risk.”
~Frank N. Newman,
United States

The Financial Balance Model
Fiscal Surplus

Current Account
Deficit

Current Account
Surplus

Domestic Private Sector
Financial Balance = 0

Fiscal Deficit
Sustainable Space for Sovereign Issuers
Fiscal Surplus

Current Account
Deficit

Current Account
Surplus

PSB = 0

Fiscal Deficit
Permissible Space Under Maastricht
Fiscal Surplus

Current Account
Deficit

Current Account
Surplus
-3%

Fiscal Deficit
Possible Space for EMU Nations
with CA Surpluses

Fiscal Surplus

Current Account
Deficit

Current Account
Surplus
-3%

Fiscal Deficit
Sustainable Space for EMU Nations
with CA Surplus

Fiscal Surplus

Current Account
Deficit

Current Account
Surplus
-3%

Fiscal Deficit
Possible Space for EMU Nations
with CA Deficits

Fiscal Surplus

Current Account
Deficit

Current Account
Surplus
-3%

Fiscal Deficit
Sustainable Space for EMU
Nations with CA Deficits
Fiscal Surplus

Current Account
Deficit

Current Account
Surplus
-3%

Fiscal Deficit
The German Problem
• Germany’s CA surpluses are increasingly viewed as
problematic
• Projected to exceed 6% of GDP this year
• Soros insists that the EZ cannot hold together as long
as countries are “divided into two classes”
• The European Commission now issues a
Macroeconomic Imbalance Scorecard
– Includes a 6% threshold on current account surpluses
– Threshold on deficits is 4%
– Possible penalties for exceeding these targets
Permissible Space With Scorecard Rules
Fiscal Surplus

Current Account
Deficit

Current Account
Surplus
-3%

+6%

-4%
Fiscal Deficit
“In a sense, the budget deficit can
be considered an artificial surplus.”

~Michael Kalecki
Implications?
• “If the Eurozone is to survive, it must become
a transfer union. And rather soon.” (Alvarez,
2012)
• Germany must help countries regain
competitiveness (Soros, 2012)
• “The only way out of this predicament is to
shift to domestic demand-led development
strategies” (Kregel, 2010)
• “Allowing prices and wages to adjust
downward will not restore employment and
growth” (Terzi, 2010)
Bottom Line
• The US, UK, Japan, Canada, etc. enjoy a degree of
fiscal space that is not available to most countries in
the Eurozone
• Government budget constraints – as usually
conceived – are not inapplicable to EZ nations
• Market discipline is a real thing
• One way or another, policy must ensure that private
sector balances are normally in (+)
• The problem is that countries that lack sovereign
money may also lack the fiscal space to help the
private sector achieve its habitual state of surplus
Thank You!

Follow me on Twitter @stephaniekelton

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Fiscal Space and Financial Stability: A Differential Analysis

  • 1. Fiscal Space and Financial Stability: A Differential Analysis The U.S. vs. The Eurozone Stephanie Kelton, Ph.D. FIELDS-INET November 1, 2013
  • 2. The Orthodox Perspective: A One-Size Fits All Attempt to Define “Fiscal Space”
  • 3. Government Budget Constraint G + iB = T + ΔB + ΔM Assumptions: Gov’t spending is “financed” by T + ΔB “Financing” gov’t spending via ΔM is inflationary “Constraint” is thus to select G such that ΔM = 0
  • 4. Intertemporal Budget Constraint Blanchard et al. 1990 ΔB = G – T + iB (note no ΔM) Rewriting in real terms and as % of real GDP: Δb = g - t + (r – Θ)b For any time, n, in the future . . . bN = b0(1+r-Θ)N + Σ(g-t)(1+r-Θ)N-k Taking present value . . . PV bN = b0 + PV projected Σ(g-t)
  • 5. Also, since then PV bN = bN / (1+r-Θ)N, Limit PV bN as N→∞ = 0 Thus, for fiscal sustainability, 0 = b0 + PV projected Σ(g-t) -b0 = PV projected Σ(g-t)
  • 6. In (Other) Words • The cumulative discounted present value of the expected future surpluses must be equal to the current national debt outstanding • If that condition is not satisfied, then the debt is not “sustainable” • Government would have to eventually repudiate its debt, either by an outright default or through the use of inflation
  • 7. Resulting in Claims Like This “Fiscal space” (shaded area) runs out as government approaches the “debt limit”
  • 8. Bad Assumptions Are Driving the Model “California’s bond rating has sunk to a level just above junk status . . . . California is teaching the U.S. a valuable lesson about the connection between fiscal policy and financial markets.” “Unless action is taken very soon to reform the main U.S. benefit programmes, Washington may have to grapple with the same crisis currently preoccupying Sacramento.” “Unresolved, the situation could cause U.S. Treasury yields to rise sharply, wreaking havoc on the national economy.” Gokhale and Smetters, Financial Times (9/7/03)
  • 9. Isn’t that What Happened in Greece?
  • 10. What’s Different About the US? • In modern (or sovereign money) systems operating with flexible exchange rates, interest rates on the national debt are a matter of political economy • “This has significant implications for the appropriate “mix” of monetary and fiscal policies, particularly if full employment and financial stability are considered fundamental goals of macroeconomic policy.” ~ Scott Fullwiler, 2006
  • 11. Fullwiler on “Fiscal Sustainability” • “In short, the orthodox concept of fiscal sustainability is flawed due to its assumption that a key variable – the interest rate paid on the national debt – is set in private financial markets as in the orthodox loanable funds framework”
  • 13. The Financial Balance Approach to Macro Stability • Understood by J.M. Keynes and early Keynesians like Nicholas Kaldor, Abba Lerner, and Joan Robinson • “Lost in the headlong rush over the past three decades of mainstream macroeconomics to become a special branch of microeconomics, which itself appears to have become a special branch of applied calculus in some sort of rather twisted physics envy.” (Parenteau, 2009)
  • 14. “Without an expansionary fiscal policy, real output cannot grow for long.” ~ Wynne Godley, 2000
  • 15. Why? • Because the US runs persistent current account deficits • This has important implications for financial stability • Godley relied on the sector balance framework to undertake his analyses • Showed that countries with current account deficits would need to run budget deficits most of the time
  • 16. Why Does it Have to be Government? • The US household sector cannot net save in nominal terms (spend less money than it earns) unless some other sector (or combination of sectors) is willing and able to spend more money than it earns. • It can be the government, the business, or the foreign sector or some mix of the three • But keep in mind, of the three, a government with a sovereign currency (not convertible into fixed quantities of a commodity or another currency on demand) and no debt denominated in foreign currencies is the only one of those three that cannot go bankrupt and cannot default on its debt while continuously deficit spending – unless it chooses to default for some odd political reason
  • 20. Godley Was a Deficit Owl He understood that this sector could only net save if these sectors (on balance) spent more than their income
  • 21. In Any Given Period • The sector balances show whether a particular part of the economy is: – Spending more than its income • Running a Deficit – Spending less than its income • Running a Surplus – Spending just equal to its income • Balancing its Budget
  • 22. Rules of the Game • Three Sectors – Domestic Private – Domestic Public – Foreign (Rest of the World) • Two Rules – They can’t all be in surplus – They can’t all be in deficit
  • 23. A Simple Accounting Fact $$$$$ Government (Public) Sector $$$$$ Non-Government Sector (Households, Firms, International Trade) Government Surplus = Non-government Deficit Government Deficit = Non-government Surplus
  • 24. In Any Nation • In practice, at least one sector will always be in deficit • Who should it be? • Godley understood that the private sector achieved a “habitual state of surplus” and that private sector deficits were unsustainable • Expansions driven by a decline in private net saving were inevitably “followed by a severe recession”
  • 25. Beware Swings in Private Net Saving
  • 26. The Private Sector Belongs in Surplus • “An increase in private debt relative to income can go on for a long time, but it cannot go on forever.” (Godley, 2000) • At some point lenders will run out of creditworthy borrowers who are willing to spend • “When that happens asset prices go sideways, sales soften, jobless claims trend higher, and economic activity falters” (Wray, 2012)
  • 27. The Private Sector Cannot Create Its Own Net Financial Assets • Assets and liabilities cancel each other out – Loans create deposits • Net financial assets must come from outside the domestic private sector • Private Sector = Public Sector + Current Account Surplus (S – I) Deficit (G – T) Surplus (X – M) • If the Public Sector is running a deficit and the current account is in surplus, the private sector will necessarily be in surplus
  • 28. What if the CA is Not in Surplus? • Can the private sector still achieve a surplus? • Yes, but only if the government deficit is bigger than the current account deficit EX: 1% = 4% - 3% • This means that countries with current account deficits must run even bigger budget deficits (as % of GDP) in order to keep the private sector in surplus
  • 29. Rest of World runs (+) balance against US Gov’t runs (+) Priv. Sect. goes (-)
  • 30. What Does this Mean for the EZ? Surplus (2012Q1, Millions CA Deficit (2012Q1, Millions CA of €) of €) Belgium -1,422 Estonia -86 Ireland -1,045 Greece -4,721 Spain Germany +41,068 Netherland s +17,454 -14,444 Austria +3,210 France -9,626 Slovakia +648 Italy -13,067 AVERAGE +12,659 Cyprus -718 Malta -54 Portugal -1,264 Slovenia -77 Finland -1,191 AVERAG E -3,976 14 of the EUR-17 run current account deficits
  • 31. How Germany Crushed the Competition • The rise of German “competitiveness” began under Chancellor Schroeder in the early 2000s • The Hartz Commission and then “Agenda 2010” – Curtailed the power of labor unions and craft guilds – Made it easier for employers to hire/fire at will – Cut unemployment benefits so that Germans now receive unemployment benefits for about
  • 32. Current Account 1996 4.0% 3.0% 2.0% Percent of GDP 1.0% 0.0% Portugal -1.0% -2.0% -3.0% -4.0% Italy Ireland Greece Spain Germany France
  • 33. Current Account 1997 4.0% 3.0% 2.0% 1.0% 0.0% Percent of GDP Portugal -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% Italy Ireland Greece Spain Germany France
  • 34. Current Account 1998 4.0% 2.0% 0.0% Percent of GDP Portugal -2.0% -4.0% -6.0% -8.0% Italy Ireland Greece Spain Germany France
  • 35. Current Account 1999 4.0% 2.0% 0.0% Percent of GDP Portugal -2.0% -4.0% -6.0% -8.0% -10.0% Italy Ireland Greece Spain Germany France
  • 36. Current Account 2000 4.0% 2.0% 0.0% Portugal Percent of GDP -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% Italy Ireland Greece Spain Germany France
  • 37. Current Account 2001 4.0% 2.0% 0.0% Portugal Percent of GDP -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% Italy Ireland Greece Spain Germany France
  • 38. Current Account 2002 4.0% 2.0% 0.0% Percent of GDP Portugal -2.0% -4.0% -6.0% -8.0% -10.0% Italy Ireland Greece Spain Germany France
  • 39. Current Account 2003 3.0% 2.0% 1.0% 0.0% Portugal Percent of GDP -1.0% -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% Italy Ireland Greece Spain Germany France
  • 40. Current Account 2004 6.0% 4.0% 2.0% 0.0% Percent of GDP Portugal -2.0% -4.0% -6.0% -8.0% -10.0% Italy Ireland Greece Spain Germany France
  • 41. Current Account 2005 6.0% 4.0% 2.0% 0.0% Percent of GDP Portugal -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% Italy Ireland Greece Spain Germany France
  • 42. Current Account 2006 8.0% 6.0% 4.0% 2.0% 0.0% Percent of GDP Portugal -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% -14.0% Italy Ireland Greece Spain Germany France
  • 43. Current Account 2007 10.0% 5.0% 0.0% Percent of GDP Portugal -5.0% -10.0% -15.0% -20.0% Italy Ireland Greece Spain Germany France
  • 44. Current Account 2008 10.0% 5.0% 0.0% Percent of GDP Portugal -5.0% -10.0% -15.0% -20.0% Italy Ireland Greece Spain Germany France
  • 45. Current Account 2009 6.0% 4.0% 2.0% 0.0% Portugal Percent of GDP -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% -14.0% Italy Ireland Greece Spain Germany France
  • 46. Current Account 2010 8.0% 6.0% 4.0% 2.0% Percent of GDP 0.0% Portugal -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% Italy Ireland Greece Spain Germany France
  • 47. Current Account 2011 8.0% Who won? 6.0% 4.0% 2.0% Percent of GDP 0.0% Portugal -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% Italy Ireland Greece Spain Germany France
  • 48. Fiscal Space with EMU “[T]he power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony.” ~Wynne Godley, 1992
  • 50. Permissible Space for Sovereign Issuers Fiscal Surplus Current Account Deficit Current Account Surplus PSB = 0 Fiscal Deficit
  • 51. May Face Self-Imposed Constraints • Debt ceiling • No overdraft rule • Fed cannot buy directly
  • 52. There are No “Market” Constraints “The treasury can always raise money by issuing securities. The bond vigilantes really have it backwards. There is always more demand for treasuries than can be allocated from a limited supply of new issues in each auction; the winners in the auctions get to place their funds in the safest most liquid form of instrument there is for US dollars; the losers are stuck keeping some of their funds in banks, with bank risk.” ~Frank N. Newman,
  • 53. United States The Financial Balance Model Fiscal Surplus Current Account Deficit Current Account Surplus Domestic Private Sector Financial Balance = 0 Fiscal Deficit
  • 54. Sustainable Space for Sovereign Issuers Fiscal Surplus Current Account Deficit Current Account Surplus PSB = 0 Fiscal Deficit
  • 55. Permissible Space Under Maastricht Fiscal Surplus Current Account Deficit Current Account Surplus -3% Fiscal Deficit
  • 56. Possible Space for EMU Nations with CA Surpluses Fiscal Surplus Current Account Deficit Current Account Surplus -3% Fiscal Deficit
  • 57. Sustainable Space for EMU Nations with CA Surplus Fiscal Surplus Current Account Deficit Current Account Surplus -3% Fiscal Deficit
  • 58. Possible Space for EMU Nations with CA Deficits Fiscal Surplus Current Account Deficit Current Account Surplus -3% Fiscal Deficit
  • 59. Sustainable Space for EMU Nations with CA Deficits Fiscal Surplus Current Account Deficit Current Account Surplus -3% Fiscal Deficit
  • 60. The German Problem • Germany’s CA surpluses are increasingly viewed as problematic • Projected to exceed 6% of GDP this year • Soros insists that the EZ cannot hold together as long as countries are “divided into two classes” • The European Commission now issues a Macroeconomic Imbalance Scorecard – Includes a 6% threshold on current account surpluses – Threshold on deficits is 4% – Possible penalties for exceeding these targets
  • 61. Permissible Space With Scorecard Rules Fiscal Surplus Current Account Deficit Current Account Surplus -3% +6% -4% Fiscal Deficit
  • 62. “In a sense, the budget deficit can be considered an artificial surplus.” ~Michael Kalecki
  • 63. Implications? • “If the Eurozone is to survive, it must become a transfer union. And rather soon.” (Alvarez, 2012) • Germany must help countries regain competitiveness (Soros, 2012) • “The only way out of this predicament is to shift to domestic demand-led development strategies” (Kregel, 2010) • “Allowing prices and wages to adjust downward will not restore employment and growth” (Terzi, 2010)
  • 64. Bottom Line • The US, UK, Japan, Canada, etc. enjoy a degree of fiscal space that is not available to most countries in the Eurozone • Government budget constraints – as usually conceived – are not inapplicable to EZ nations • Market discipline is a real thing • One way or another, policy must ensure that private sector balances are normally in (+) • The problem is that countries that lack sovereign money may also lack the fiscal space to help the private sector achieve its habitual state of surplus
  • 65. Thank You! Follow me on Twitter @stephaniekelton