European Fiscal and Monetary Policy

With the Eurozone economy weakening, many commentators are calling on the European Central Bank (ECB) to provide fresh stimulus. But what if the diverse monetary policy tools used by the ECB since the financial crisis have reached the limits of their effectiveness in promoting recovery? Could European governments contribute to stimulating the economy by increasing public spending or reducing taxes? And should fiscal policy now be focused more on raising demand by ‘loosening the public purse strings’ than on reducing public debt?

We invited our European panel of economic experts to express their views on the potential roles of fiscal and monetary policy in boosting demand and output in the Eurozone. We asked the experts whether they agreed or disagreed with the following statements, and, if so, how strongly and with what degree of confidence:

a) At this point, there is little that the European Central Bank can do to increase or maintain output in the Eurozone.

b) When the economy is operating below its potential, larger fiscal deficits are likely to increase demand and output.

c) When the economy is operating below its potential and monetary policy is at the effective lower bound, fiscal policy should prioritize increasing output over decreasing public debt.

Monetary policy effectiveness

Of our 50 experts, 42 participated in this survey. On the first statement, 4% said they had no opinion. Of the 40 who did express a view and weighted by each expert’s confidence in their response, 2% strongly agreed, 57% agreed, 14% were uncertain, 18% disagreed and 9% strongly disagreed.

In the short comments that the experts are able to include when they participate in the survey, there is an indication of what lies behind the differences of opinion. For example, Christopher Pissarides at the London School of Economics (LSE) pointed out that: ‘There is no evidence of bottlenecks in the financial sector that monetary policy could relax’; while Peter Neary at Oxford argued that: ‘The ECB can’t do much given low interest rates, but it can stop things getting worse.’

Several experts mentioned the monetary policy tools that the ECB has used or could use. Among those who think that the limits of monetary policy effectiveness are close, Charles Wyplosz at the Graduate Institute, Geneva, said: ‘A few basis points won’t make a difference and liquidity is not an issue now.’ Olivier Blanchard at the Peterson Institute noted that: ‘The ECB can buy large quantities, but with little effect on prices (so long as it keeps the capital key, and it does not buy exotic assets).’

Some who disagreed with the statement referred to what else might be done. For example, Lubos Pastor at Chicago Booth suggested: ‘There’s little room to cut rates, but ECB could also relaunch QE [quantitative easing], expand bank loans, change forward guidance. Weaker euro could help output.’ Former central bank governor Patrick Honohan at Trinity College Dublin added: ‘Still some unused powder: restart QE, remove ceiling on holdings; tilt purchases towards high yield assets, etc.’

Franklin Allen of Imperial College London, who replied that he was uncertain, commented on the ECB’s policy instruments: ‘It is probably close to the limits of what it can achieve using previous tools. But there may be new ones they can come up with.’

Karl Whelan at University College Dublin, who strongly disagreed that there is little the ECB can do, emphasized: ‘With an unemployment rate of 7.5% there is still spare capacity in the euro area. ECB can also boost investment, which increases supply capacity.’

Christian Leuz at Chicago Booth alluded to the important roles of other policy-makers in promoting economic recovery: ‘The ECB has bought countries and EU considerable time for structural reforms, but its measures also eased pressures for necessary reforms.’ And Paul De Grauwe at the LSE drew attention to the need to add fiscal stimulus to the policy mix, leading neatly on to the second and third statements: ‘We are still in a liquidity trap making it difficult for a central bank to boost the economy without fiscal stimulus.’

Fiscal policy for growth

For the second statement – on whether larger fiscal deficits are likely to increase demand when the economy is operating below capacity– 6% of the 42 experts who participated in this survey said that they had no opinion. Of the 39 who did express a view and weighted by each expert’s confidence in their response, 35% strongly agreed, 50% agreed, and 16% were uncertain.

John Van Reenen at MIT was one of several experts pointing to: ‘Lots of evidence now of the positive effect of fiscal policy at the zero lower bound.’ Christopher Pissarides exclaimed: ‘Old fashioned Keynesianism works!’

Others echoed a comment by Beatrice Weder di Mauro of the Centre for Economic Policy Research: ‘The question is how much.’ For example, Pol Antras at Harvard said: ‘Debate is largely about how much and on how to do it (increase spending and on what, cut taxes, etc.).’

But there were several caveats expressed. Although all three agreed with the statement, Per Krusell at Stockholm University noted: ‘If the government’s money isn’t wasted’; Olivier Blanchard said: ‘Unless utterly irresponsible, in which case adverse effects may dominate’; and Hélène Rey at London Business School commented: ‘Stimulate aggregate demand unless larger fiscal deficit means higher risk premium, in which case higher interest burden will decrease aggregate demand.’

Two experts who said they were uncertain also mentioned caveats. Christian Leuz pointed out that: ‘Depends also on time horizon over which outcome is considered.’ Franklin Allen added: ‘Maybe in the short run but in the long run, good investment decisions associated with innovation are likely to have more effect.’

Boosting output over reducing public debt

For the third statement – on whether fiscal policy should prioritize increasing output over decreasing public debt – 4% of the 42 experts who participated in this survey said that they had no opinion. Of the 40 who did express a view and weighted by each expert’s confidence in their response, 17% strongly agreed, 45% agreed, 34% were uncertain and 5% disagreed.

Among those who agreed with the statement, there were again caveats. Antoinette Schoar at MIT said: ‘Answer depends on the type of government projects, some crowd out private sector activity, others are net beneficial, needed infrastructure.’ Agnès Bénassy-Quéré at the Paris School of Economics commented: ‘To the extent that the government can borrow at fixed long-term rate.’ And Peter Neary observed: ‘Agree, but this is more a political/moral judgment than a scientifically grounded view. And depends on circumstances, especially size of deficit.’

Several experts remarked on the debt position of countries choosing to make growth a priority over debt reduction. Xavier Freixas at the Universitat Pompeu Fabra said: ‘It depends upon the existing level of public debt and its impact on sovereign risk.’ Karl Whelan commented: ‘Generally true though not, for example, in highly indebted members of the euro area which do not have control of their own currency.’

Charles Wyplosz was not so convinced about the importance of current debt levels: ‘Fiscal space is determined by policy institutions, more than the existing gross debt: fiscal councils; central bank lending in last resort.’

Of those who disagreed with the statement, Jan Pieter Krahnen of Goethe University Frankfurt explained: ‘I disagree because of unconditional nature of the statement. What if Ricardian equivalence holds, and investment function bends backwards?’

All comments made by the experts are in the full survey results.

Romesh Vaitilingam
@econromesh
July 2019

 

Question A:

At this point, there is little that the European Central Bank can do to increase or maintain output in the Eurozone.

Responses weighted by each expert's confidence

Question B:

When the economy is operating below its potential, larger fiscal deficits are likely to increase demand and output.

Responses weighted by each expert's confidence

Question C:

When the economy is operating below its potential and monetary policy is at the effective lower bound, fiscal policy should prioritize increasing output over decreasing public debt.

Responses weighted by each expert's confidence

Question A Participant Responses

Participant University Vote Confidence Bio/Vote History
Allen
Franklin Allen
Imperial College London
Uncertain
5
Bio/Vote History
It is probably close to the limits of what it can achieve using previous tools. But there may be new ones they can come up with.
Antras
Pol Antras
Harvard
Uncertain
5
Bio/Vote History
Besley
Timothy J. Besley
LSE Did Not Answer Bio/Vote History
Blanchard
Olivier Blanchard
Peterson Institute
Agree
9
Bio/Vote History
The ECB can buy large quantities, but with little effect on prices. (so long as it keeps the capital key, and it does not buy exotic assets)
Bloom
Nicholas Bloom
Stanford
Disagree
7
Bio/Vote History
Blundell
Richard William Blundell
University College London
Uncertain
2
Bio/Vote History
Bénassy-Quéré
Agnès Bénassy-Quéré
Paris School of Economics
Agree
4
Bio/Vote History
Carletti
Elena Carletti
Bocconi
Uncertain
4
Bio/Vote History
Danthine
Jean-Pierre Danthine
Paris School of Economics
Agree
9
Bio/Vote History
De Grauwe
Paul De Grauwe
LSE
Agree
7
Bio/Vote History
We are still in a liquidity trap making it difficult for a central bank to boost the economy without fiscal stimulus
Eeckhout
Jan Eeckhout
UPF Barcelona
Agree
6
Bio/Vote History
Fehr
Ernst Fehr
Universität Zurich
Agree
8
Bio/Vote History
Freixas
Xavier Freixas
Barcelona GSE
Strongly Agree
6
Bio/Vote History
Fuchs-Schündeln
Nicola Fuchs-Schündeln
Goethe-Universität Frankfurt Did Not Answer Bio/Vote History
Galí
Jordi Galí
Barcelona GSE
Agree
8
Bio/Vote History
Garicano
Luis Garicano
LSE Did Not Answer Bio/Vote History
Giavazzi
Francesco Giavazzi
Bocconi
Uncertain
10
Bio/Vote History
Griffith
Rachel Griffith
University of Manchester
No Opinion
Bio/Vote History
Guerrieri
Veronica Guerrieri
Chicago Booth
Uncertain
8
Bio/Vote History
Guiso
Luigi Guiso
Einaudi Institute for Economics and Finance
Agree
8
Bio/Vote History
Honohan
Patrick Honohan
Trinity College Dublin
Disagree
10
Bio/Vote History
Still some unused powder: Restart QE; remove ceiling on holdings; tilt purchases towards high yield assets, etc.
Javorcik
Beata Javorcik
University of Oxford
Uncertain
3
Bio/Vote History
Kleven
Henrik Kleven
Princeton Did Not Answer Bio/Vote History
Krahnen
Jan Pieter Krahnen
Goethe University Frankfurt
Agree
6
Bio/Vote History
The ECB can influence output via interest rates if and only if the investment function is monotonic everywhere. But this may not be true.
Krusell
Per Krusell
Stockholm University
Agree
6
Bio/Vote History
Kőszegi
Botond Kőszegi
Central European University
No Opinion
Bio/Vote History
La Ferrara
Eliana La Ferrara
Harvard Kennedy Did Not Answer Bio/Vote History
Leuz
Christian Leuz
Chicago Booth
Agree
2
Bio/Vote History
The ECB has bought countries and EU considerable time for structural reforms, but its measures also eased pressures for necessary reforms.
Mayer
Thierry Mayer
Sciences-Po Did Not Answer Bio/Vote History
Meghir
Costas Meghir
Yale Did Not Answer Bio/Vote History
Neary
Peter Neary
Oxford
Disagree
4
Bio/Vote History
ECB can’t do much given low interest rates, but I can stop things getting worse
O'Rourke
Kevin O'Rourke
Oxford
Disagree
6
Bio/Vote History
Pagano
Marco Pagano
Università di Napoli Federico II
Agree
6
Bio/Vote History
Pastor
Lubos Pastor
Chicago Booth
Disagree
9
Bio/Vote History
There's little room to cut rates, but ECB could also relaunch QE, expand bank loans, change forward guidance. Weaker euro could help output.
Persson
Torsten Persson
Stockholm University Did Not Answer Bio/Vote History
Pissarides
Christopher Pissarides
London School of Economics and Political Science
Agree
10
Bio/Vote History
There is no evidence of bottlenecks in the financial sector that monetary policy could relax
Portes
Richard Portes
London Business School
Disagree
9
Bio/Vote History
Prendergast
Canice Prendergast
Chicago Booth
Agree
7
Bio/Vote History
Reichlin
Lucrezia Reichlin
London Business School
Agree
9
Bio/Vote History
Repullo
Rafael Repullo
CEMFI
Agree
8
Bio/Vote History
Rey
Hélène Rey
London Business School
Strongly Disagree
8
Bio/Vote History
Has to prevent fall in inflationary expectations
Schoar
Antoinette Schoar
MIT
Agree
7
Bio/Vote History
Sturm
Daniel Sturm
London School of Economics
Disagree
3
Bio/Vote History
Van Reenen
John Van Reenen
LSE
Strongly Disagree
7
Bio/Vote History
Vickers
John Vickers
Oxford
Agree
5
Bio/Vote History
Voth
Hans-Joachim Voth
University of Zurich
Agree
7
Bio/Vote History
Weder di Mauro
Beatrice Weder di Mauro
The Graduate Institute, Geneva
Agree
6
Bio/Vote History
Not much much with the existing toolkit
Whelan
Karl Whelan
University College Dublin
Strongly Disagree
8
Bio/Vote History
With an unemployment rate of 7.5% there is still spare capacity in the EA. ECB can also boost investment which increases supply capacity.
Wyplosz
Charles Wyplosz
The Graduate Institute Geneva
Agree
8
Bio/Vote History
A few basis points won't make a difference and liquidity is not an issue now.
Zilibotti
Fabrizio Zilibotti
Yale University
Agree
5
Bio/Vote History

Question B Participant Responses

Participant University Vote Confidence Bio/Vote History
Allen
Franklin Allen
Imperial College London
Uncertain
5
Bio/Vote History
Maybe in the short run but in the long run good investment decisions associated with innovation are likely to have more effect.
Antras
Pol Antras
Harvard
Agree
5
Bio/Vote History
Debate is largely about how much and on how to do it (increase spending and on what, cut taxes, etc.)
Besley
Timothy J. Besley
LSE Did Not Answer Bio/Vote History
Blanchard
Olivier Blanchard
Peterson Institute
Strongly Agree
9
Bio/Vote History
Unless utterly irresponsible, in which case adverse effects may dominate
Bloom
Nicholas Bloom
Stanford
Agree
7
Bio/Vote History
Blundell
Richard William Blundell
University College London
Agree
2
Bio/Vote History
Bénassy-Quéré
Agnès Bénassy-Quéré
Paris School of Economics
Strongly Agree
10
Bio/Vote History
The problem is to calculate the potential.
Carletti
Elena Carletti
Bocconi
Uncertain
4
Bio/Vote History
Danthine
Jean-Pierre Danthine
Paris School of Economics
Agree
9
Bio/Vote History
De Grauwe
Paul De Grauwe
LSE
Agree
8
Bio/Vote History
Eeckhout
Jan Eeckhout
UPF Barcelona
Uncertain
6
Bio/Vote History
Fehr
Ernst Fehr
Universität Zurich
Agree
8
Bio/Vote History
Freixas
Xavier Freixas
Barcelona GSE
Strongly Agree
8
Bio/Vote History
Fuchs-Schündeln
Nicola Fuchs-Schündeln
Goethe-Universität Frankfurt Did Not Answer Bio/Vote History
Galí
Jordi Galí
Barcelona GSE
Agree
8
Bio/Vote History
Garicano
Luis Garicano
LSE Did Not Answer Bio/Vote History
Giavazzi
Francesco Giavazzi
Bocconi
Agree
5
Bio/Vote History
Griffith
Rachel Griffith
University of Manchester
No Opinion
Bio/Vote History
Guerrieri
Veronica Guerrieri
Chicago Booth
Agree
9
Bio/Vote History
Guiso
Luigi Guiso
Einaudi Institute for Economics and Finance
Uncertain
6
Bio/Vote History
Honohan
Patrick Honohan
Trinity College Dublin
Agree
10
Bio/Vote History
Javorcik
Beata Javorcik
University of Oxford
No Opinion
Bio/Vote History
Kleven
Henrik Kleven
Princeton Did Not Answer Bio/Vote History
Krahnen
Jan Pieter Krahnen
Goethe University Frankfurt
Uncertain
6
Bio/Vote History
There are two caveats in the statement: first, output is below potential, and second, Ricardian equivalence does not hold.
Krusell
Per Krusell
Stockholm University
Agree
7
Bio/Vote History
If the government’s money isn’t wasted.
Kőszegi
Botond Kőszegi
Central European University
No Opinion
Bio/Vote History
La Ferrara
Eliana La Ferrara
Harvard Kennedy Did Not Answer Bio/Vote History
Leuz
Christian Leuz
Chicago Booth
Uncertain
2
Bio/Vote History
Depends also on time horizon over which outcome is considered.
Mayer
Thierry Mayer
Sciences-Po Did Not Answer Bio/Vote History
Meghir
Costas Meghir
Yale Did Not Answer Bio/Vote History
Neary
Peter Neary
Oxford
Strongly Agree
5
Bio/Vote History
Only models with implausible degrees of wage/price flexibility predict otherwise.
O'Rourke
Kevin O'Rourke
Oxford
Strongly Agree
8
Bio/Vote History
Pagano
Marco Pagano
Università di Napoli Federico II
Uncertain
7
Bio/Vote History
Pastor
Lubos Pastor
Chicago Booth
Agree
6
Bio/Vote History
Persson
Torsten Persson
Stockholm University Did Not Answer Bio/Vote History
Pissarides
Christopher Pissarides
London School of Economics and Political Science
Strongly Agree
10
Bio/Vote History
Old fashioned Keynesianism works!
Portes
Richard Portes
London Business School
Strongly Agree
10
Bio/Vote History
Prendergast
Canice Prendergast
Chicago Booth
Agree
7
Bio/Vote History
Reichlin
Lucrezia Reichlin
London Business School
Agree
9
Bio/Vote History
Repullo
Rafael Repullo
CEMFI
Agree
4
Bio/Vote History
Rey
Hélène Rey
London Business School
Strongly Agree
8
Bio/Vote History
Stimulate aggregate demand unless larger fiscal deficit mean higher risk premium in which case higher interest burden will decrease AD
Schoar
Antoinette Schoar
MIT
Uncertain
7
Bio/Vote History
Sturm
Daniel Sturm
London School of Economics
Agree
5
Bio/Vote History
Van Reenen
John Van Reenen
LSE
Strongly Agree
9
Bio/Vote History
Lots of evidence now of the positive effect fiscal policy at zero lower bound
Vickers
John Vickers
Oxford
Agree
5
Bio/Vote History
Voth
Hans-Joachim Voth
University of Zurich
Agree
8
Bio/Vote History
Weder di Mauro
Beatrice Weder di Mauro
The Graduate Institute, Geneva
Agree
9
Bio/Vote History
The question is how much.
Whelan
Karl Whelan
University College Dublin
Strongly Agree
10
Bio/Vote History
There is plenty of empirical evidence for this proposition.
Wyplosz
Charles Wyplosz
The Graduate Institute Geneva
Strongly Agree
8
Bio/Vote History
The literature is now wide and converging.
Zilibotti
Fabrizio Zilibotti
Yale University
Agree
5
Bio/Vote History

Question C Participant Responses

Participant University Vote Confidence Bio/Vote History
Allen
Franklin Allen
Imperial College London
Uncertain
5
Bio/Vote History
It depends on the circumstances of the country. If it is not very indebted and public investment would be beneficial then it makes sense.
Antras
Pol Antras
Harvard
Agree
6
Bio/Vote History
Besley
Timothy J. Besley
LSE Did Not Answer Bio/Vote History
Blanchard
Olivier Blanchard
Peterson Institute
Strongly Agree
9
Bio/Vote History
costs of debt small. (output) benefits of deficits large
Bloom
Nicholas Bloom
Stanford
Uncertain
7
Bio/Vote History
Blundell
Richard William Blundell
University College London
Uncertain
2
Bio/Vote History
Bénassy-Quéré
Agnès Bénassy-Quéré
Paris School of Economics
Agree
5
Bio/Vote History
To the extent that the government can borrow at fixed long term rate
Carletti
Elena Carletti
Bocconi
Uncertain
4
Bio/Vote History
Danthine
Jean-Pierre Danthine
Paris School of Economics
Agree
9
Bio/Vote History
De Grauwe
Paul De Grauwe
LSE
Agree
8
Bio/Vote History
Eeckhout
Jan Eeckhout
UPF Barcelona
Uncertain
7
Bio/Vote History
Fehr
Ernst Fehr
Universität Zurich
Agree
5
Bio/Vote History
Freixas
Xavier Freixas
Barcelona GSE
Uncertain
10
Bio/Vote History
It depends upon the existing level of public debt and its impact on sovereign risk.
Fuchs-Schündeln
Nicola Fuchs-Schündeln
Goethe-Universität Frankfurt Did Not Answer Bio/Vote History
Galí
Jordi Galí
Barcelona GSE
Agree
8
Bio/Vote History
Garicano
Luis Garicano
LSE Did Not Answer Bio/Vote History
Giavazzi
Francesco Giavazzi
Bocconi
Disagree
7
Bio/Vote History
Griffith
Rachel Griffith
University of Manchester
No Opinion
Bio/Vote History
Guerrieri
Veronica Guerrieri
Chicago Booth
Uncertain
10
Bio/Vote History
Guiso
Luigi Guiso
Einaudi Institute for Economics and Finance
Uncertain
7
Bio/Vote History
Honohan
Patrick Honohan
Trinity College Dublin
Agree
Bio/Vote History
Javorcik
Beata Javorcik
University of Oxford
Agree
7
Bio/Vote History
Kleven
Henrik Kleven
Princeton Did Not Answer Bio/Vote History
Krahnen
Jan Pieter Krahnen
Goethe University Frankfurt
Disagree
6
Bio/Vote History
I disagree because of unconditional nature of the statement. What if Ricardian equivalence holds, and investment function bends backwards?
Krusell
Per Krusell
Stockholm University
Uncertain
5
Bio/Vote History
Ok if debt position is not in danger zone.
Kőszegi
Botond Kőszegi
Central European University
No Opinion
Bio/Vote History
La Ferrara
Eliana La Ferrara
Harvard Kennedy Did Not Answer Bio/Vote History
Leuz
Christian Leuz
Chicago Booth
Uncertain
2
Bio/Vote History
Mayer
Thierry Mayer
Sciences-Po Did Not Answer Bio/Vote History
Meghir
Costas Meghir
Yale Did Not Answer Bio/Vote History
Neary
Peter Neary
Oxford
Agree
4
Bio/Vote History
Agree, but this is more a political/moral judgement than a scientifically grounded view. And depends on circumstances, esp. size of deficit
O'Rourke
Kevin O'Rourke
Oxford
Strongly Agree
8
Bio/Vote History
Pagano
Marco Pagano
Università di Napoli Federico II
Uncertain
7
Bio/Vote History
Pastor
Lubos Pastor
Chicago Booth
Agree
6
Bio/Vote History
Persson
Torsten Persson
Stockholm University Did Not Answer Bio/Vote History
Pissarides
Christopher Pissarides
London School of Economics and Political Science
Agree
9
Bio/Vote History
The only potential problem I see is that confidence in the country might fall and affect investment otherwise I would say strongly agree
Portes
Richard Portes
London Business School
Strongly Agree
9
Bio/Vote History
Prendergast
Canice Prendergast
Chicago Booth
Agree
7
Bio/Vote History
Reichlin
Lucrezia Reichlin
London Business School
Agree
9
Bio/Vote History
Repullo
Rafael Repullo
CEMFI
Uncertain
4
Bio/Vote History
it depends on the level of public debt.
Rey
Hélène Rey
London Business School
Uncertain
8
Bio/Vote History
It depends on the country. At high debt level risk premium increase can more than undo aggregate demand stimulus
Schoar
Antoinette Schoar
MIT
Agree
7
Bio/Vote History
Answer depends on the type of government projects, some crowd out private sector activity others are net beneficial, needed infrastructure
Sturm
Daniel Sturm
London School of Economics
Agree
3
Bio/Vote History
Van Reenen
John Van Reenen
LSE
Strongly Agree
10
Bio/Vote History
Vickers
John Vickers
Oxford
Uncertain
5
Bio/Vote History
Yes if fiscal position is sound but not necessarily otherwise
Voth
Hans-Joachim Voth
University of Zurich
Strongly Agree
8
Bio/Vote History
Weder di Mauro
Beatrice Weder di Mauro
The Graduate Institute, Geneva
Uncertain
7
Bio/Vote History
Depends on the debt level
Whelan
Karl Whelan
University College Dublin
Agree
8
Bio/Vote History
Generally true though not, for example, in highly-indebted members of the Euro Area which do not have control of their own currency.
Wyplosz
Charles Wyplosz
The Graduate Institute Geneva
Agree
9
Bio/Vote History
Fiscal space is determined by policy institutions, more than the existing gross debt: fiscal councils central bank lending in last resort.
Zilibotti
Fabrizio Zilibotti
Yale University
Agree
9
Bio/Vote History