VoxEU Column Europe's nations and regions Global crisis Macroeconomic policy

Periphery economies: National governments must be prepared to provide stimulus

Despite recent calm in the markets, the Eurozone crisis seems far from over. So far, responses have worked little magic. This column argues that at some point soon, Eurozone governments will be forced by voters to reverse austerity and stimulate growth. A number of policy options are available, but it is clear that pro-growth fiscal stimulus policies should take their place. Longer-term fiscal consolidation will nonetheless also be required to reduce excessive levels of public spending relative to GDP.

Periphery countries are continuing to face deepening impoverishment for no good reason. With real incomes falling and unemployment already approaching 20 or 30%, further austerity is unnecessary and unconscionable. The crisis is spreading. France, a country near the centre, is increasingly in difficulty, and now even Germany’s growth is faltering.

The IMF (2013) has recently demonstrated that fiscal multipliers are higher than previously estimated and, with austerity policies in place, this means, ceteris paribus, that the current contraction will be deeper than previously anticipated. De Grauwe and Ji (2013) have also fairly convincingly shown with simple cross-country comparisons that the stronger the austerity policies are, the greater is the related economic contraction. They also demonstrate that the stronger the austerity policies, the greater is the related increase in public debt burdens. These are important and compelling results.

Furthermore, the latest statistics show that the downturn in industrial production continues unabated in almost all periphery countries, with activity generally now around 30% below pre-crisis peaks, and no relief in sight.

Based on this unfolding evidence, one cannot escape the conclusion that, to date, austerity policies not only have not achieved their objectives, but they have actually proven to be counter-productive. It is now obvious to all that the current European macroeconomic policy orthodoxy is misplaced in the new era of high debt and renewed recession.

And the storms are far from over. On the basis of the IMF’s World Economic Outlook forecasts released in October 2012 – which are certain to underestimate the magnitude of the problems ahead (given the IMF’s more recent multiplier analysis) – cumulative budget deficits as a proportion of GDP over the years 2013 to 2016 are estimated to be as follows: France 9.5% of GDP, Greece 12%, Ireland 17%, Italy 6%, Portugal 10.7%, and Spain 17.3%. These ongoing deficits will need to be financed. If these deficits are to be financed by new bond issues then public debt will rise to intolerable levels; credit rating agencies, investors and financial markets will respond accordingly. New financial crises will be prone to erupt on any bad news, lender of last resort facilities notwithstanding.

Unless things are turned around soon, the situation could become catastrophic. The central macroeconomic policy problem can no longer be ignored; the planning required for its resolution cannot be delayed until the German elections are out of the way, or until a stronger fiscal and monetary union is established (if ever that is achieved).

The required macroeconomic policy response

In preparation, therefore, let us assume national governments do decide to inject economic stimulus. The big policy question then becomes how can monetary and fiscal policies be changed to achieve this result without adding further to public debt, when interest rates are already at near the zero lower bound?

In respect of fiscal policy, Lerner and Keynes pointed out long ago that the financing of fiscal deficits can be achieved in three ways: new bond financing, taxation, or by new money.

In their policy map, McCulley and Possar (2013) point to increased monetary and fiscal policy coordination – so called ‘helicopter money’ – as the final, end-game form of quantitative easing (new money creation) that is “… certain to boost nominal demand, add to economic growth and reduce slack”.

Turner (2013) and Wolf (2013) have recently argued that monetisation of the fiscal deficit should be considered as a possible viable policy option. Others before them – including Keynes (1933), Lerner (1943), Friedman (1948), Bernanke (2002), and Buiter (2012) – have all identified this particular policy option as relevant in certain circumstances. These economists do not believe that budget deficits are, in and of themselves, evil, or in any way offensive, as they may needed to compensate for inadequate private demand. Some believe that monetisation of the deficit is generally superior and more powerful to new bond financing because there is no crowding-out with monetary financing. I believe that deficit spending financed by new money creation is the optimal monetary/fiscal policy combination to address excessive public debt and falling output simultaneously.

What I have attempted to emphasise in my own contributions (see, for example, Wood 2012) is that it is the ‘new government bond financing’ of budget deficits that is the indefensible and unpardonable paradigm in a period of already high public debt; as new bond financing adds directly to ‘public debt’ burdens (also see Wood 2013).

Under the deficit monetisation proposal, there would be no large-scale injection of new money and, as the new money is required only for the purpose of providing the initial economic stimulus, it could be withdrawn subsequently (by sterilisation) if ever that became necessary due to the economy overheating.

Practical implementation issues

The policy of deficit monetisation requires thoughtful consideration and careful planning prior to its implementation. There is, for instance, a need to consider the effects of accounting treatments, credit rating agency assessments and the mechanisms by which governments and independent central banks can coordinate their functions.

While no liability is created when new fiat money is created and issued by central banks (see Buiter 2003), it is nevertheless the case, as in the US and the UK for instance, that if new government bonds are issued to independent central banks in exchange for new money (to finance the budget deficit) then general government debt increases, based on current accounting standards. Credit rating agencies review changes in general government debt when preparing country credit ratings. Presumably credit rating agencies ‘look through’ and recognise that government bonds held by the central bank could be sold into the market at any time. Consequently it is likely that independent central banks cannot generally finance budget deficits in exchange for new government bonds without increasing ‘public debt’, as it is currently measured.

Policy options

Lord Turner and the Financial Times newspaper have called for public debate on these important and pressing issues.

In that context, let us identify a number of policy options that might be explored as ways to stimulate economic growth without further increasing public debt. The list below is not intended to be exhaustive. The most obvious possibilities are:

  • Change the accounting standards and the measurement of ‘public debt’ and require that credit rating agencies take into account the fact that issuers of new fiat money create no liability.

This is unlikely to be successful while ever independent central banks can sell government bonds into the private market.

  • Governments could legislate to enable Ministries of Finance (not the independent central bank) to create new local legal tender currency to be used to finance on going budget deficits, and any increased budget deficits judged necessary to provide economic stimulus.

This option would result in two currencies circulating simultaneously, a possibility not without successful precedent. If it is deemed appropriate, the national central banks and/or the ECB could be required to redeem the new local currency for euros at the face value of the euro on demand. This last-mentioned action might possibly provide scope for a technical circumvention of Article 123 of the Lisbon Treaty.

  • Governments could require that the Ministry of Finance create new local currency money that is immediately swapped at the national central bank and/or the ECB for (new) euro, and the (new) euros are then used to finance the budget deficit. At a later date the currency swap could be reversed.
  • Governments could require that the Ministry of Finance issue special non-transferable new government bonds to the national central bank and/or the ECB in exchange for (new) euro to be used to finance the fiscal deficits. At a later date, if and when appropriate, these bonds could be redeemed.

A number of these options may possibly require (depending on legal analysis) that Article 123 of the out-dated Lisbon Treaty be rescinded, adjusted, circumvented or over-ridden.


Macroeconomic policy logic, recent statistical trends and the available forecasts highlighted above inexorably lead to the view that monetisation of the deficit may represent the optimal policy paradigm needed to simultaneously achieve economic growth and debt stabilisation.
When real incomes are collapsing, when private demand is grossly deficient and falling, when interest rates are at record lows, when public debt is grossly excessive, when further deleveraging is required, when austerity policies have back-fired, and when monetary transmission mechanisms are partly dysfunctional, national governments are morally obliged to step-up and provide fiscal support to stimulate aggregate demand to lower excessive unemployment.

Defensive monetary and fiscal policies cannot stabilise debt or restore economic growth. Furthermore, continued reliance on new bond financing of budget deficits will only compound and intensify current problems and raise public debt further. Continuation of these policies would drag economies downward and represent a further colossal policy blunder.

Based on the available statistical evidence and the logic in this column, austerity programs should be wound-back, with pro-growth fiscal stimulus policies taking their place. Longer-term fiscal consolidation will nonetheless also be required to reduce excessive levels of public spending and taxation relative to GDP, and to contribute to the reduction in public debt over time.

Editors’ note: This column was received on 24th February 2013.


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Blanchard, O and L Leigh (2013), “Growth forecast errors and fiscal multipliers”, IMF Working Paper, WP/13/1.

Buiter, W (2003), “Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap”, NBER Working Paper, No. 10163, December.

Buiter, W and E Rahbari (2012), “What More can Central Banks do to Stimulate the Economy’, Global Economics View, Citi, 9 May.

De Grauwe, P and Y Ji (2013), “Panic-driven austerity in the Eurozone and its implications”, VoxEU.org, 21 February.

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Friedman, M (1969), Optimum Quantity of Money, Aldine Publishing Company, 1969.

IMF (2012), World Economic Outlook Database, October.

Keynes, J (1933), Open Letter to President Roosevelt.

Lerner, A (1943), “Functional Finance and the Public Debt”, Social Research 10.

McCulley, P and Z Pozsar (2013), “Helicopter money: or how I stopped worrying and love fiscal-monetary cooperation”, Global Society of Fellows, 7 January.

Turner, A (2013), “Debt, Money and Mephistopheles: How Do We Get Out Of This Mess”, Cass Business School Lecture, 6 February.

Wolf, M (2013), “The case for helicopter money’, Financial Times, 12 February.

Wood, R (2012), How to Solve the European Economic Crisis: Challenging orthodoxy and creating new policy paradigms, Amazon Books, 19 December.

Wood, R (2013), “Helicopter money is purely about initial stimulus”, Financial Times Letters, 17 February.

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