Fiscal space on the eurozone periphery and the use of the (partially) balanced-budget multiplier: The case of Spain

ABSTRACT

This article adopts the “functional finance” approach to consider the utilization of expansive fiscal policies in the members of the European Monetary Union most affected by high unemployment. As they do not have their own monetary policy, fiscal deficits require the issuing of public debt without the support of the central bank. The authors consequently incorporate the notion of a (partially) balanced-budget expansion to achieve the desired stimulus in gross domestic product (GDP) with the least possible effect on public debt. Their proposal is only a sort of “imperfect” balanced-budget expansion: It is based on the idea that simultaneous increases in public revenue and expenditure can boost GDP, but without any pretension of keeping public deficit unchanged. Specifically, the authors use the case of Spain to show that a more expansive fiscal policy is desirable on economic grounds, and that only institutional constraints prevent it. They do it presenting two alternative scenarios for the coming years and analyzing their different impact on unemployment and fiscal sustainability. The first represents a firm commitment to budget consolidation, whereas the second is based on this “imperfect” application of the balanced budget multiplier. The main conclusion is that a more expansive fiscal policy is perfectly compatible with finance sustainability.

KEYWORDS:

• Balanced budget multiplier
• fiscal policy
• fiscal space
• functional finance
• Spain

JEL CLASSIFICATIONS:

• E61
• E62

Notes

¹An increase in the structural primary deficit equivalent to 0.5% of eurozone GDP.

²From an academic standpoint, Stockhammer, Constantine, and Reissl (2016) pointed out that in spite of some convergence toward post Keynesian positions on economic policy proposals, especially on fiscal policy and the role of the ECB, there is still almost no connection between the new Keynesian literature on fiscal multipliers (Blanchard and Leigh 2013) and the effects of fiscal policy on the one hand, and practical policy recommendations for the eurozone, on the other. Thus, far from finding it supportive of a more expansive and discretionary fiscal policy, we remain sceptical over the EC’s shift towards this kind of Keynesianism.

³According to the Fiscal Compact, this MTO should imply the achievement of a balanced structural deficit. Nevertheless, Sawyer (2013a) provided sound economic arguments against the rationale of this objective: “a balanced budget and economy operating at potential output are in generally incompatible and hence a balanced structural budget is not possible.”

⁴The European Commission (2016b) itself “is of the opinion that the Draft Budgetary Plan is at risk of non-compliance with the provisions of the SGP. … Therefore, in line with the Commission Communication ‘Towards a positive fiscal stance for the euro area’, further measures will be needed to meet the headline deficit and structural effort targets going forward” (p. 4).

⁵See Truger (2015) for a discussion of the problems related to estimating this concept and the pro-cyclical bias of the methodology used by the European Commission.

⁶This strategy is consistent with the latest Stability Programs presented by the Spanish government, where all the expected reduction in public deficit as a percentage of GDP resulted from decreasing public expenditure over GDP ratios.

⁷The structural balance is a highly problematic concept, both from a theoretical and an empirical standpoint, since it is a non-observable variable whose value is based on estimating potential GDP and the nonaccelerating rate of unemployment. For example, in this forecast the IMF considers that the output gap will be zero in Spain in 2019, with an unemployment rate of 16%. Nevertheless, we use these figures here because they are included in the Fiscal Compact.

⁸Uxó and Álvarez (2016) use the same equations to analyze the consequences of the last Stability Programme presented by the Spanish government.

⁹Differentiating between the discretionary and the cyclical component of expenditure and tax changes is strictly speaking not necessary when applying empirical estimates of the multiplier which can be interpreted to typically already include all cyclical or otherwise endogenous changes. We use the differentiation nevertheless for reasons of technical clarity. It should be noted that using standard empirical multiplier estimates within our approach generates considerably smaller multipliers Ω_G and Ω_T in Equation (1b) below which can be interpreted as cautious estimates of the multipliers.

¹⁰Godar, Paetz, and Truger (2014) provided theoretical and empirical arguments for progressive tax reforms in the current context.

¹¹We assume that the increase in the revenue/GDP ratio takes place progressively over the whole period, from 37.4% in 2016 to 41.0% in 2020 (t* increases by 0.9 percentage points each year).

¹²Actually, this fact provides a new argument for an increase in public expenditure: driving public investments that are able to foster a new energy model, based on renewable energy sources and that is less dependent on fossil fuels.

¹³Certain valuation effects could also affect the evolution of NIIP. However, they are not taken into account here, because we are mainly interested in analyzing the change in the NIIP derived from the effect of our expansive fiscal policy proposal on net exports.

Additional information

Notes on contributors

Jorge Uxó

Jorge Uxó is with the Department of Economic Analysis and Finance, University of Castilla–La Mancha, La Mancha, Spain.

Ignacio Álvarez

Ignacio Álvarez is with the Department of Economic Structure, Autonomous University of Madrid, and with Complutense Institute of International Studies (ICEI), Madrid, Spain.

Eladio Febrero

Eladio Febrero is with the Department of Economic Analysis and Finance, University of Castilla–La Mancha, La Mancha, Spain.