Full employment policy in the periphery without the euro exit

By Rob Parenteau

First of all, if a government stops having its own currency, it doesn’t just give up ‘control over monetary policy’…If a government does not have its own central bank on which it can draw cheques freely, its expenditures can be financed only by borrowing in the open market, in competition with businesses, and this may prove excessively expensive or even impossible, particularly under ‘conditions of extreme urgency’…The danger then is that the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression it is powerless to lift.

So wrote the late Wynne Godley in his August 1997 Observer article, “Curried Emu”. The design flaws in the euro were, in fact, that evident even before the launch – at least to those economists willing to take the career risk of employing heterodox economic analysis. Wynne’s early and prescient diagnosis may have come closest to identifying the ultimate flaw in the design of the eurozone – a near theological conviction that relative price adjustments in unfettered markets are a sufficiently strong force to drive economies back onto full employment growth paths.

Otherwise, why would policymakers willingly agree to give up much of their discretion in using monetary policy, fiscal policy, and exchange rate policy tools that had conventionally been used to stabilize economic growth? One would only pitch the proposal of expansionary fiscal consolidation if one shared a near theological conviction in the stabilizing properties of markets left to their own devices.

The failure of this neoliberal experiment is now all too obvious. Greece, for example, has traveled an economic trajectory over the last half decade that in many respects rivals that of the US in the Great Depression. While the immediate response of policymakers to such a failed live experiment might be to exit the euro, the short run costs of doing so can be very high. The sharp declines in newly introduced currencies on foreign exchange markets would be likely to sharply raise the cost of imported goods, and foreign investors would likely go on strike, at least until the currency had hit bottom. In the case of Greece, with fuel, food, and medicine making up a large share of the import bill, further economic disruption and destabilization would likely result from a choice to exit the eurozone. Exiting the euro does not appear to be an option – at least not one without a large risk of introducing further turmoil.

The task then becomes to thread the policy needle – namely, to exit austerity, without exiting the euro. The following simple proposal introduces an alternative financing mechanism, along with safeguards to minimize the risk of abuse of this mechanism, which may accomplish this threading of the needle.

If we can agree with the late Wynne Godley that the separation of central bank monetary policy from fiscal policy is one of the core design flaws of the eurozone, and we can acknowledge that the expansionary fiscal consolidations promised five years ago have proven anything but expansionary, then it is clear that effective demand must be revived by other measures. If private sector investment demand is going to continue to prove to weak (especially relative to private saving preferences), and if the increase in trade balance is going to continue to be made largely through import contraction (on the back of weak final domestic demand), then economic growth can only return if countries abandon austerity measures. Simply put, peripheral nations in the eurozone must regain control of their fiscal policy, and must actively pursue full employment growth policies.

To accomplish this, the following alternative public financing instrument may need to be unilaterally adopted in each peripheral nation in the eurozone. Federal governments will henceforth issue revenue anticipation notes to government employees, government suppliers, and beneficiaries of government transfers. These tax anticipation notes, which are a well known instrument of public finance by many state governments across the US, will have the following characteristics: zero coupon (no interest payment), perpetual (meaning no repayment of principal, no redemption, and hence no increase in public debt outstanding), transferable (can be sold onto third parties in open markets), and denominated in euros. In addition, and most importantly, these revenue anticipation notes would be accepted at par value by the federal government in settlement of private sector tax liabilities. The revenue anticipation notes could be distributed electronically to bank accounts of firms and households through some sort of encrypted and secure system, or they could be sent as certificates, preferably in denominations of 50 and 100 euros, to facilitate their possible ease of use in other transactions, should private agents elect to do so. Essentially, the government is securitizing the future tax liabilities of its citizens, and creating what amounts to a tax credit that will not be counted as a liability on its balance sheet, and will not require a stream of future interest payments in fiscal budgets.

One advantage of this alternative financing approach is that day one, the government issuing these tax anticipation notes (we could call them G Notes for Greece, I Notes for Italy, S Notes for Spain, etc.) can pursue the fiscal deficits that are required to return their economy to a full employment growth path. Fiscal austerity can be abandoned without abandoning the euro.

The explicit cost of this approach could involve the imposition of fines for violating the 3% fiscal deficit to GDP ratio of the Growth and Stability Pact. However, Germany openly violated this threshold in the last decade with no fines imposed, and so what is good for the goose, must be good for the gander. Moreover, if renewed fiscal stimulus is successful enough to revive the economy, tax revenues will rise, and public debt to GDP ratios are likely to fall. After all, the outcome of recent episodes of fiscal consolidation has been rising, not falling debt to GDP ratios, as fiscal restraint has held back nominal GDP growth, or led to outright declines in nominal incomes. Finally, in countries with current account deficits that are in excess of 3% of GDP, the rules of double entry bookkeeping imply countries will need to violate the 3% fiscal deficit to GDP rule if their domestic private sectors are to be kept off of deficit spending paths.

In addition, the use of these tax anticipation notes will tend to free up more euros for payment of externally held public debt. Euros may also be freed up to pay for imports of essential goods like food, fuel, and medicine as well, at least until fiscal policy can help develop domestic production in these areas. With both the ECB and eurozone commercial bank balance sheets shrinking over the past year, the supply of euros may be contracting. This contraction of bank balance sheets may be making it more difficult for each country to acquire more euros by selling assets or tradable goods to holders (and more importantly, creators) of euros.

Of course, to make this alternative financing mechanism, enforcement of tax collection will need to be improved in some nations. A more equally distribution of the tax burden across citizens would also help in the issuance of these notes. To accomplish this, citizens will also need to take back their democracies from what Jamie Galbraith has termed the predator state. Otherwise, there is a risk that programs facilitated by the issuance of tax anticipation notes will just become another vehicle for political patronage.

A second criticism of this alternative financing mechanism is that it would offer a quick route to accelerating inflation, if not hyperinflation, as some of the constraints on government budgets would be reduced or removed. To address this, it might be helpful for the central bank of each country to be held responsible for not only monitoring inflation conditions, but also for creating early warning systems for the possible acceleration of inflation. Both exercises could be overseen and validated by an independent third party – say IMF or ECB staff.

Hard rules could then be set in place along the following lines: should inflation accelerate through say a 4% YoY ceiling for more than six months in any nation, the Treasury of that nation would have to implement an across the board sequestration on government spending of 5%. This sequestration would remain in effect until the inflation rate dropped below 4% for at least six months. A schedule for ratcheting such measures if inflation continues to accelerate above the ceiling could surely be devised. Alternatively, taxes could be increased on households to create a deferred savings pool, much as Singapore currently employs, and much as Keynes proposed for WWII England.

In addition, public/private inquiries into the specific location of supply bottlenecks in the chain of production could trigger the redirection of infrastructure spending to help clear those bottlenecks. Inquiries into sectors with above normal profit margins or real wage growth persistently in excess of labor productivity growth could also be launched. Excess profit taxes designed to incentivize higher reinvestment rates, as well as collaborative bargaining in cases of aggressive labor demands, could be required to address any such inflationary pressures on the supply side. Using these tax anticipation notes to implement an employer of last resort approach to labor market improvement could also have a stabilizing effect on inflation. It is not hard, in other words, to create the demand and supply side policy mechanisms that could reduce the odds of an ever-accelerating inflation once fiscal policy is liberated.  After all, the fear of this outcome is one of the reasons the eurozone was designed with precisely the division between central banks and fiscal policy that Wynne Godley identified in the opening quote.

Austerity has proven to be a disaster on nearly all fronts. It is time to abandon the fatal conceit of the neoliberals. Economies are not naturally drawn to full employment growth paths when prices are free to adjust . We know this from the theories of Keynes, Fisher, and Minsky, and we know it from historical and direct experience – yet this was the central premise, as well as the fundamental design flaw, behind the European Monetary Union. This theology of “markets uber alles” has been demonstrated to be very questionable, if not deceitful, both in theory and in practice. The human cost of the neoliberal conceit has proven both tragic and unacceptable. Furthermore, this live and misguided experiment in neoliberalism has set in motion dynamics of political and social polarization and dissolution – dynamics that are blatantly antithetical to the original unifying intention supposedly behind the eurozone project.

Yet countries can, in fact, exit the hell of enforced austerity policies without having to take on the very significant challenges of exiting the euro. It is possible to thread the needle. Through this alternative financing mechanism, the tax anticipation notes, countries can regain control of their fiscal policy, and mend the design flaw that Wynne Godley identified well before the first euro had even been issued. Perhaps there would be no better tribute to the man, as well as to the powerful and useful insights of heterodox economics, as the foundation and relevance of mainstream economics is increasingly in question. Another world is possible. There is, in fact, contrary to Lady Thatcher, an alternative. That alternative may very well be within reach, but only if current policymakers are willing to embrace innovative policy measures like the tax anticipation notes proposed herein.

Rob is currently sole proprietor of MacroStrategy Edge, where he uses macroeconomic insights to inform U.S. equity and global balanced-portfolio strategy. For more than two decades, Parenteau served as chief U.S. economist and investment strategist at RCM, an investment management company that is part of Allianz Global Investors. Rob is also Research Associate at the Levy Economics Institute of Bard College.


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