Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 16 April 2013

Framing: Taxpayers money and Fiscal Space at the IMF

Taxpayers Money




The actual phrase that I was going to use, and which is so often used, is that some item of government spending represents ‘a cost to the taxpayer’. Additional government spending could be financed by raising income taxes. But it might not be. It could be financed by cutting some type of government transfer. [1] In fact, in the UK at the moment, if you had to guess what was the most likely source of finance for the marginal item of government spending, it would be cuts in welfare benefits. So the probability is that the phrase ‘this is a cost that welfare recipients will bear’ will be more accurate than ‘this is a cost that taxpayers will bear’. Yet I have never seen the first phrase used.

Is this me being pedantic? I would argue this is an example of framing. A related phrase is ‘tax relief’. There is nothing incorrect about using the phrase, but it equates the idea of paying taxes with some kind of affliction. An alternative phrase might be ‘tax dodge’, which has completely the opposite connotation, invoking taxes as a duty which someone is unfairly not fulfilling. I think another example is ‘free market’. Those who favour market solutions often use ‘free market’ instead of just saying ‘market’. We all want to be free. But an alternative description might be ‘unregulated market’, which sounds (to most) less good. One final example might be intellectual property, but I am sure there are many more. [2]

Fiscal Space at the IMF

Unlike the phrases discussed above, ‘fiscal space’ is less widely used, but I want to argue that it too frames a debate in a biased way. There are many good things in the just issued ‘Rethinking Macro Policy II: Getting Granular’ by Blanchard, Dell'Ariccia and Mauro at the IMF. Their discussion of ‘Should Central Banks Explicitly Target Activity’ reflected many of the points I tried to make recently here, although of course they were not rude about the ECB. But the section on fiscal policy was strange, and it made me think about why I have always been reluctant to use the phrase ‘fiscal space’.

The section of the paper on fiscal policy goes as follows. (The letters in brackets refer to the subsections in the paper, and I will use them as references below.) Government debt is too high and needs to come down (A). For some countries where a default premium on government debt has emerged, then debt reduction has to be rapid. The idea that monetary policy could help in these circumstances raises the problem of fiscal dominance (B). In other countries there is ‘fiscal space’, so debt consolidation does not have to be so quick (C). Maybe these countries might think about redesigning their automatic stabilisers (D).

Fiscal space is like a breathing space. The debate is all about the speed of fiscal consolidation, and some countries can afford to take a small breather before getting back on the consolidation path. Taking a breather might be a good idea, because going too fast may have some unintended consequences when we are stuck at a zero lower bound. The idea of active fiscal stimulus becomes reduced to a slower speed of fiscal consolidation and tinkering with automatic stabilisers.

Take this sentence from the paper. “Underlying the debate about multipliers has been the question of the optimal speed of fiscal consolidation (with some in the United States actually arguing for further fiscal stimulus).” Well one or two people outside the US have been arguing for fiscal stimulus too, but the key message here is that there is just one primary role for fiscal policy (fiscal consolidation), and anything to do with multipliers and recovering from recessions just influences its speed.

This framing is wrong. Fiscal policy has two roles. In normal times outside of a monetary union the primary role should be debt stabilisation/reduction. At the zero lower bound the primary role should be fiscal stimulus. In a monetary union both roles are equally important all the time. Framing fiscal policy discussion around the idea of fiscal space negates the countercyclical role. This negation was a key factor behind the Eurozone crisis, and more generally it has intensified and prolonged the current recession.

One of the features of framing is that it is not literally wrong (it is not like the doublespeak of Orwell’s Ministry of Peace ). In the statements above, I agree with (A). But once you concede it is all about (A), then the discussion of (B) and (C) becomes distorted, and the policy endpoint (D) becomes quite inadequate. In fact, you suspect that part of the idea is to deliberately avoid the thought that governments could use fiscal policy in a discretionary manner to stimulate the economy. (The word countercyclical appears only once in the paper.) In that sense, I’m afraid to say, the IMF inhabit the same fiscal space as the European Commission!

[1] Reaction functions relating policy to debt, for example, find no systematic tendency for taxes to respond by more than spending: some evidence is briefly reviewed here. Current austerity programs vary from spending based to tax based: see the IMF analysis reported here.

[2] An earlier version of this post, before I read the IMF paper, ended with a different link. Just as the phrase ‘taxpayers money’ presumed incorrectly that (income) taxes were the residual source of finance, too much macroeconomic analysis of temporary government spending changes uses income taxes as the residual source of finance. This allows opponents of fiscal stimulus too much scope: see for example John Taylor’s latest analysis of the impact of austerity, as discussed by Noah Smith here. The few theoretical cases of expansionary austerity that have been produced nearly all depend on these supply side effects of higher future income taxes outweighing the current impact of higher government spending: see also Campbell Leith here. It would be much better, as I have suggested before, if we instead focused in the first instance on what I have called ‘pure’ countercyclical policy: in this case higher government spending eventually paid for by lower government spending. This way we separate issues to do with intertemporal demand management (the business cycle) from issues to do with tax incentives. I couldn’t decide whether this link inspired or contrived.


  1. The EZ is simply no proper monetary union and it will likely see some improvements because of the crisis, but also these will not make it one.
    Fiscally everybody is on its own, unless circumstances force to do it otherwise like via contagion fears.

    In scientific terms I would like to see neutral terminology for neutral things and positive for generally positive (id. for negative).
    With a lot of the words I have however in practice less problems than you seem to have. Just the way things are called. Also with things like stimulus (slightly positive wording for a thing that is at least half the time not necessary plus usually about what is on top of say already a 5-10% deficit) or multiplier which is usually <1.

    Fiscal space looks to me pretty neutral. And within the context of the EZ only in one direction.
    Also relevant in this issue as nobody was going to lend the PIIGS any money for stimulus. Neither the market nor the fellow EZ states (including the ECB).
    So yes the normal procedure would likely have been stimulus but for practical reasons like getting that financed not possible.
    And monetary policies are because of the treaty arrangements only very limitedly possible.
    Probably more correct would be start with fiscal policy in general ==> negative situation ===> question fiscal space or not. Or Negative situation ===> stimulus ===> unless no fiscal space.
    Imho a small (increase in) premium should in a lot of situations not be a partykiller. It is looking at the pro and the cons. In 2008 with collapsing bank fears it was probably wise to take some risk, simply to prevent the bottom would fall out. Only the country involved should realise that lateron it likely would have an extra price to pay.
    Which is one of the problems as that lookks politically difficult to sell. Europe has to grow up in that respect.

    A nice mess, fully agree, a completely failed construct.

    With also very limited possibilities to improve the thing (and the role of the ECB in it) plus have proper enforcement of rules and those kind of things, to a standard that makes it a proper fuctioning monetary union.

    Which brings me on a very similar problem as your post. All economist come with solutions for this particular crisis.
    First of all they often leave reality at home and assume the ECB is similar to the FED or that it is a proper functioning monetary union and if not changes can be made more or less from one day to the other.
    Second that solving this crisis will get to a sustainable monetary union. It likely will not be one. This second point is completely forgotton. Solve this one and most likely in the future we see something similar as the construct might have been improved but still sucks big time. In that respect the very realistic question should you save something that will likely cause another crisis in the future? But a question that is never asked.

    Politically the answer will be yes as it is over the 2 year horizon. But from an economic pov the costs of a next crisis should simply be plugged in and these are now forgotten.

    My idea is that as likely proper monetary union can be set up and crisis mechanisms remain similar, decisionmaking works the same way, it is simply not worth rescuing.

  2. In trying to remedy the ongoing economic problems, it does seem odd that policy makers in Europe and the UK are willing to try a range of policies - QE, austerity in various guises and to varying degrees, supply-side in the shape of more labour market deregulation etc; but definately not discretionary fiscal policy to stimulate the economy, even if other policies have had a modest impact, or more likely have made matters worse and have simply prolonged the crisis.
    To what extent might it be an ideological issue? - with policy makers here and in Europe having too much invested politically and in terms of reputation in existing policy, together with the notion that any discretionary fiscal stimulus would be resorting to a Keynesian response? This is viewed as anathema to many policy makers, and in turn would be an admission that they have made dreadful policy mistakes and considerably worse economic harm and hardship than necessary for millions over the past 5 years.

    1. My 5cts.

      Not one reason. Reality is much too complicated for that. But there are more and less important reasons.

      Main problem imho is that politicians donot want to go back to their voters and state that yes we demand 50% or more of your income and promised a lot of things. However we still want that 50% but you can forget half the promises we made.

      The traditional political parties and their policies are in the process to be found out. They are looking for a way out, but they went past that door a few years ago. Basically they are in general in the Hans Brinker stage thumb in the dyke while a few meters away water already start to drip as well. And people in such a situation just live by the day especially as they donot oversee the situation they are in as well.

      Look at the EZ simply failed decision to start with it, still the policymakers or better their successors fail to admit there are huge mistakes made (a few do but most paper over the mistakes made). And what is worse the proposed 'new set up' doesnot really look that it is going to work as well. But with so many failures already coming to the surface they see no alternative. So they continue with a rescue operation in which they have invested nearly all their own political capital until a point not only the original set up but also the rescue itself becomes religion-like.

      So yes it is probably for a large part ideological or even religion-like. Probably only to be reversed by a completely other class of politicians. Which probably lead to a situation that for a few years to come it remains this way of crisis management. Merkel cannot move much she has simply too much invested in the present way.
      The by far most likely replacements are the populists, not really something to look forward to.

      I doubt btw if your stimulus would be as effective as in smaller dips. There are simply too many things completely out of balance with all 3 of the sectors.
      It is hard to see, if you split the economy in these 3 or 4 sectors, were growth would have to come from under these particular circumstances.

      -Consumers see their income hit now for 5-6 year in a row, job uncertainty, low interest is eating up the pensions requiring higher premia, housing sector still doesnot look healthy (in the UK most of Europe it is sick), aging hitting in (not great for spending). Hard to see these will spend more. Or better they will spend more because of a stimulus but as the US shows now they are trying to delever as well.


    2. 2) Investors (real ones) are waiting what the rest does. the crisis took too long so now it looks they want to see clear proof of especially more consumption first.
      Anyway even if it was only to spread risk a normal business would start to look abroad or allocate more abroad. Europe simply stinks. You might end up with no market because of no growth but Hollande style taxes.

      -Government already deep in debt. Which makes a say 3-5 year 10% deficit very risky. If it fails to get the thing started the only thing left is the printing press. Basically Hollande got yellow carded and with a last warning by the market in a few months time. Partly by his stupid rethoric, but will others do that better? My guess somewhat but still pretty awful. Anyway with no quick results to show it could end up as a shot in the foot as well.
      Markets like stimulus, but hate high debt. In that respect partly in the UK an issue of riskmanagement, both economically and politically.
      There is no platform, Germans, Dutch in general simply donot trust you guys.
      Would have been better, less risky, to try at the start. But there was no real political will or better urgency so it didnot happen.
      Another lesson from this crisis, nothing happens if not forced by real urgency (on the ground things start to go wrong, not when people like us can calculate easily things will go wrong).

      -Outside world. Simply also not doing great. US soso and EMs ok but not enough to carry the whole worldeconomy. Stimulus won't be a worldwide policy. So only one doing it, will likely see alot stimulus dripping away.

  3. "To what extent might it be an ideological issue?"

    I tend to think of these things in terms of mechanisms, so my guess is that what we are seeing is political responses to public perceptions. I have been following events with some attention since housing started looking like a bubble, and the thing I have noticed about comments from the public is that their intuitions about economics are extremely strange. The public are deeply invested in the "household fallacy" as a model of the national economy, and those are the people politicians need to get votes from.

    So politicians talk in ways that pander to public intuitions, even when they are not quite acting the way they talk. Osborne is running a - declining - public sector deficit and calling that austerity. The word appeals to Tory voters who think Governments should be run frugally and who have not the slightest idea what problem Keynes was trying to solve or how he recommended solving it.

    Milliband has his own problems, of course. When he talks about stimulus, he sounds like an old-fashioned tax and spend socialist, and the public - mostly, apart from Romney's 47% - have an intuition that this is a bad thing also.

    I think the bottom line really is that in a democracy there really is a limit to what policies you can get the public to accept, and that limit in economics is set by public education, which in the UK is very deficient in economics except among people who specialise in economics. If we want to voters to be wiser, we will have to teach economics to every schoolchild as routinely as we teach reading, writing and arithmetic.

    1. @jon
      1. A major part of the cause of the problem being that traditional politics have simply let their voters down. They promised much more than they could deliver. And the process that they have been found out has clearly started and is well on its way. Leaders that are not trusted are never followed.
      Especially on the cost side of things it has run out of hand. In a way that high deficits were needed to keep the thing running (with a lot of the costs simply off balance sheet like aging).
      And basically all major traditional political parties suffer the same problem. basically a combination of disappoitment in your 'normal' political party combined with disappointment in politics in general.
      Economist have a similar problem. They have presented themselves way too much in a political way and as a consequence are seen by many as part of the elite, the uncredible dishonest elite as they see it. You donot hang out with the fat guys if you want to be popular, football team is a much better option.

      2. Populists stepped into that gap and pretty successfully.
      That and the internet and the newsflows there, have created a totally different playing field.
      In a way the problem of free speech and democracy. Or better one of the side effects (a pretty major one btw).

      3. Effectively to remain in ower all traditional parties have moved to the middle to catch the 15-20% hanging votes. And these are undecided.

      4. UK/Europe need to make choices urgently and act on those choices. The world is moving forward and Europe is busy with its midlife depression.
      However these choices are unpopular with large groups (including a lot of the 'electoral middlegroup'). So they are postponed until there is a platform.

      5. There is a limit in what people accept, agree. But that limit has considerably be limited further by the way traditional political parties have run things.
      A lot of the measures that are postponed are simply as said postponed. They will have to happen anyway. But it is politically inconvenient to do it now. Causing an economy that is going sideways and when it is solved a much higher debt and aging hitting even harder. A bit of leadership by politicians would not be bad. This is simply counterproductive.

      Which brings up another European problem people are simply not used to accept the negatives of a choice and certainly not the possibility that things can go wrong for them personally. Not used to face a possible negative outcome of their choices. They are clearly still in denying.

      In a way the world's old man, in a midlife crisis, with the experience of an adolescent. Or may be better an alcoholic. Not a great combination.

  4. Perfect Competition implies something innately good could be another example and deeply embedded in the discipline of Economics

