Stéphane Auray and AurélienEyquem

The
strong globalization of economies has increased interest in the importance of markups
for companies with an international orientation. A markup is defined as the
difference between the marginal cost of production and the selling price.
Empirical evidence is accumulating to show that these markups have increased
significantly in recent years (Autor, Dorn, Katz, Patterson, and Reenen, 2017;
Loecker, Eeckhout, and Unger, 2020) and that large corporations account for a
growing share of the aggregate fluctuations (Gabaix, 2011). Moreover, the
dispersion of markups is considered in the literature as a potential source of a
misallocation of resources – capital and labour – in both economies considered to
be closed to international trade (see Restuccia and Rogerson, 2008, or Baqaee
and Farhi, 2020) and economies considered to be open to trade (Holmes, Hsu and
Lee, 2014, or Edmond, Midrigan and Xu, 2015). Finally, it has recently been
shown by Gaubert and Itskhoki (2020) that these markups are a key determinant
of the granular origin – i.e. linked to the activity of big exporters – of
comparative advantages, or in other words, they may be a determinant of trade competitiveness.

In
a recent paper (Auray and Eyquem, 2021), we introduce a dispersion of profit
margins by assuming strategic pricing viaBertrand-type competition in a
two-country model with endogenous variety effects and international trade along
the lines of Ghironi and Melitz (2005). Our aim is to understand the
interaction between these margins, firm productivity and entry-and-exit
phenomena in domestic and foreign markets. If there are distortions in the
allocation of resources, as is usually the case in these models, our corollary
objective is to study the implementation of optimal fiscal policy.

In
models with heterogeneous firms such as Ghironi and Melitz (2005), firms are
assumed to be heterogeneous in terms of individual productivity. The most
productive firms are more likely to enter markets, because they are better able
to pay fixed entry costs, whether in local or export markets. Moreover, because
these firms are more efficient, their production costs are lower, which allows
them to capture larger market shares. These effects, which seem relatively
intuitive, have already been widely validated empirically.

In
general, the introduction of strategic pricing behaviour allows firms with
larger market shares to benefit from greater price-setting power, which leads
them to charge higher markups – it being understood that the resulting selling
prices may be lower than those of their competitors. A growing literature on
international trade emphasises the importance of this kind of strategic
behaviour and the resulting dispersion of markups for determining patterns of
trade openness and their sectoral composition (see, for example, Bernard,
Eaton, Jensen and Kortum, 2003; Melitz and Ottaviano, 2008; Atkeson and
Burstein, 2008) but also for the magnitude of the welfare gains associated with
trade (Edmond, Midrigan and Xu, 2015). Indeed, in addition to the usual impact
of openness to trade, it could also reduce the adverse effects of the dispersion
of markups through the resulting increase in competition, thereby boosting its
positive effects.

First,
as expected, when fiscal policy is passive, Bertrand competition generates a
distribution of markups such that firms that are larger – hence the more
productive firms – offer lower prices, attract larger market shares and obtain
higher profit margins. Moreover, the mechanism for the selection of exporting
firms described by Melitz (2003) implies that these firms are more productive
and therefore charge higher markups. These results are intuitive and consistent
with the observed distribution of markups (see Holmes, Hsu, and Lee, 2014).

Second,
we characterize the optimal allocation of resources and show how it can be
implemented. The best possible equilibrium fully corrects for price distortions
and implies a zero dispersion of markups and a near zero level of markups. It
is implemented, as is often the case in this literature, by generous subsidies
that cancel out markups while preserving the incentive for firms to enter
domestic and export markets, i.e. by allowing them to cover the fixed costs of
entry. This first-order equilibrium can be achieved using a combination of subsidies
for a firm’s specific sales, a tax scheme on profits that differentiates between
non-exporting and exporting firms, and a specific labour tax.

In
a similar model where markups are assumed to be the same for all firms, the
best equilibrium is the same but, in contrast, much easier to implement through
a single policy instrument: a uniform and time-varying subsidy for all firms.

In
both cases, the gains associated with such policies are very large compared to the
laissez-faire case, representing a potential increase in household consumption
of around 15%. However, given the complexity of implementing a scheme with
heterogeneous markups and a cost to the public purse of over 20% of GDP –
implementation requires large amounts of subsidies, whether the markups are
heterogeneous or homogeneous – we consider second-order alternative policies,
where the number of policy instruments is limited and the government budget must
be balanced. We find that these restrictions significantly reduce the ability
of policy makers to cut the welfare losses associated with the laissez-faire
equilibrium, and that only one-third of the potential welfare gains can be
implemented in this case.

Third,
while the first-order allocations are independent of the degree of pricing
behaviour, we find that the welfare losses observed in the laissez-faire
equilibrium are lower when markups are heterogeneous and higher on average than
the markups observed in the absence of strategic pricing. While this may seem
surprising, the result can be rationalized by considering the effects of markup
dispersion on both the intensive markup – the
quantity produced per firm – and the extensive markup – the number of firms in
the markets. Indeed, Bertrand competition implies that the dispersion and the
average level of markups are positively related. Markup dispersion thus
increases the level of markups with two effects. On the one hand, all other
things being equal, higher markups reduce the quantity produced by each firm – the
intensive markup – and induce a misallocation of resources that generates
welfare losses. On the other hand, higher markups imply higher expected profits
for potential entrants, which stimulates entry and thus increases the number of
existing firms – the extensive markup. According to our model, the welfare
gains associated with the second effect dominate the welfare losses associated
with the first effect. The result therefore implies that the dispersion of markups
can generate welfare gains, at least when no other tax or industrial policy is
pursued.

Fourth,
while the previous results mainly focus on the implications of our model and
the associated optimal policies on average over time, we also study their
dynamic properties. Within the framework of passive (laissez-faire) fiscal
policies, when the economy experiences aggregate productivity shocks – technological,
for instance – the model behaves broadly like the Ghironi and Melitz (2005)
model. An original prediction of our model is that markups are globally
countercyclical while export markups are procyclical. The optimal policy
involves adjustments in tax rates in order to reverse this trend, to align all markups
over the business cycle and to make all markups procyclical. These results are
consistent with the findings of studies that focus on the optimal cyclical
behaviour of markups with heterogeneous firms in closed (Bilbiie, Ghironi and
Melitz, 2019) and open (Cacciatore and Ghironi, 2020) economy models. However, conditionally
on aggregate productivity shocks, the dispersion of markups has little effect
quantitatively compared to a similar model with homogeneous markups.

Finally,
in the spirit of Edmond, Midrigan and Xu (2015), we conducted a trade
liberalization experiment whereby the costs of trade gradually and permanently
decline to almost zero. We find that the long-run welfare gains are much larger
when the policy implemented is optimal. On the other hand, the laissez-faire
equilibrium indicates that short-run welfare gains are affected by markup
dispersion. Indeed, markup dispersion affects the dynamics of business creation
resulting from trade liberalization in a critical way. As in Edmond, Midrigan
and Xu (2015), markup dispersion reduces the long-run welfare gains from trade,
but for a different reason: it affects the dynamism of business creation and
reduces the number of firms in the long run. However, since in this case fewer
resources are invested in the short run to create new companies, consumption
increases more at the intensive markup in the short and medium run – less than
10 years. While the long-run welfare gains from trade integration vary from 12%
to 14.5%, depending on the calibration, the short-run welfare gains with
heterogeneous markups can be up to 3% larger than with homogeneous markups.

The
conclusions of this study lead to an approach to corporate profit margins that
is more nuanced than that usually found in the literature. Indeed, while the markups
and their dispersion do have negative effects on the economy, they also have an
important role to play in the phenomena of business entry and participation in
international markets. Our work is a complement to a strictly microeconomic
approach to industrial policy issues, which would conclude unequivocally that
the market power at the origin of these markups is harmful. As such, in the
manner of Schumpeter, this calls for a more balanced view of the role of company
markups in modern economies, which would show a tension between distortions of
competition and incentives to business creation.

Bibliographic references

Auray Stéphane and Aurélien Eyquem, 2021, “The
dispersion of Mark-ups in an Open Economy”.

Autor David, David Dorn, Lawrence F. Katz,
Christina Patterson and John Van Reenen, 2017, “Concentrating on the Fall of
the Labor Share”, American Economic Review, 107 (5):180-185.

Baqaee David Rezza and Emmanuel Farhi, 2020, “Productivity
and Misallocation in General Equilibrium”, The Quarterly Journal of Economics, 135 (1):105-163.

Berman N., P. Martin and T. Mayer, 2012, “How do
Different Exporters React to Exchange Rate Changes?”, Quarterly Journal of Economics, 127 (1):437-492.

Bernard Andrew B., Jonathan Eaton, J. Bradford
Jensen and Samuel Kortum, 2003, “Plants and Productivity in International Trade”,
American
Economic Review, 93
(4):1268-1290.

Bilbiie Florin O., Fabio Ghironi and Marc J.
Melitz, 2008, “Monetary Policy and Business Cycles with Endogenous Entry and
Product Variety”, In NBER Macroeconomics Annual 2007, Volume 22, NBER Chapters. National Bureau of
Economic Research, Inc, 299-353.

Bilbiie Florin O., Fabio Ghironi and Marc J.
Melitz, 2019, “Monopoly Power and Endogenous Product Variety: Distortions and
Remedies”, American
Economic Journal: Macroeconomics,
11 (4):140-174.

Cacciatore Matteo, Giuseppe Fiori and Fabio
Ghironi, 2016, “Market Deregulation and Optimal Monetary Policy in a Monetary
Union”, Journal
of International Economics,
99 (C):120-137.

Cacciatore Matteo and Fabio Ghironi, 2020,
“Trade, Unemployment, and Monetary Policy”, NBER Working Paper, 27474.

Edmond Chris, Virgiliu Midrigan and Daniel Yi Xu,
2015, “Competition, Markups, and the Gains from International Trade”, American Economic Review, 105(10):3183-3221.

Etro Federico and Andrea Colciago, 2010,
“Endogenous Market Structure and the Business Cycle”, Economic Journal, 120(549):1201-1233.

Gabaix Xavier, 2011, “The Granular Origins of
Aggregate Fluctuations”, Econometrica, 79(3):733-772.

Gaubert Cecile and Oleg Itskhoki, 2020,
“Granular Comparative Advantage”, Journal of Political Economy (forthcoming).

Ghironi F. and M. J. Melitz, 2005, “International
Trade and Macroeconomic Dynamics with Heterogeneous Firms”, Quarterly Journal of Economics, 120(3):865-915.

Holmes Thomas J., Wen-Tai Hsu and Sanghoon Lee,
2014, “Allocative Efficiency, Mark-ups, and the Welfare Gains from Trade”, Journal of International Economics, 94(2):195-206.

Loecker Jan De, Jan Eeckhout and Gabriel Unger,
2020, “The Rise of Market Power and the Macroeconomic Implications
[“Econometric Tools for Analyzing Market Outcomes”]”, The Quarterly Journal of Economics, 135(2):561-644.

Melitz Marc J., 2003, “The Impact of Trade on
Intra-Industry Reallocations and Aggregate Industry Productivity”, Econometrica, 71(6):1695-1725.

Melitz Marc J. and Gianmarco I. P. Ottaviano, 2008,
“Market Size, Trade, and Productivity”, Review of Economic Studies, 75(1):295-316.

Restuccia Diego and Richard Rogerson, 2008, “Policy
Distortions and Aggregate Productivity with Heterogeneous Establishments”, Review of Economic Dynamics, 11(4):707-720.

by Pierre
Aldama

Between 1999 and 2019, the eve of the Covid-19
pandemic, the public debts of the 11 oldest euro zone members had risen by
an average of 20 percentage points of GDP. This increase in public debt is
commonly attributed to structural budget deficits, particularly those in the
pre-crisis period and in the “South”. But how much of the stock of public debt
in 2019 can be attributed to structural deficits, and how much to GDP growth,
interest payments or cyclical deficits? In this post, we use the December 2020
edition of the OECD’s Economic
Outlook to break down the changes in public debt into its main factors:
structural and cyclical primary balances, the interest burden, nominal GDP
growth and stock-flow adjustments. This shows that the structural deficits
generally contributed less than is commonly assumed, and that the increase in
public debt over the period was largely the result of the direct and indirect
consequences of the double-dip recession in the euro zone.

On the eve of the Covid-19 crisis, the 11 oldest
euro zone countries had an average level of public debt (in the Maastricht
sense) of 92% of GDP. Between 1999 and 2019, the public debt in these 11
countries increased by an average of 20 percentage points of GDP, although with
considerable heterogeneity (Figure 1). On the one hand, a group of so-called
virtuous countries – Germany, the Netherlands, Austria, Finland and Ireland – reduced
their debt ratios to their 1999 level of 60% of GDP or even lower. In contrast
to this were the countries whose public debt increased – France, Spain, Greece
and Portugal – or remained at a high level – Belgium and Italy. Can we simply
deduce from this that there are some countries that acted like the proverbial
ant and others like the grasshopper? Probably not.

Indeed, not all countries entered the European
Monetary Union (EMU) with the same level of debt: their starting point
therefore biases observation insofar as it does not inform about the structural
or cyclical factors or to the interest burden associated with the fiscal policy
in place from 1999 to 2019. Is the rise in public debt in the “grasshopper” countries
largely attributable to the accumulation of structural deficits, or on the
contrary, to cyclical factors and the impact of the recessions in the euro zone
(2008-2010 and 2011-2013)?

This post uses the December 2020 edition of the
OECD’s Economic Outlook to break down the changes inpublic debt into the main components: structural
and cyclical primary balances, the interest burden, nominal GDP growth and
stock-flow adjustments. This shows that the contribution of structural deficits
is generally lower than commonly assumed and that the increase in public debt
over the period largely results from the direct and indirect consequences of
the double-dip recession in the euro zone.

The accounting decomposition of public debt
dynamics

The change in public debt (as a percentage of GDP)
between year t and year t-1 can be broken
down into five main factors, using the following equation:

where r_t / (1+y_t) d_t-1 is
the effect of the interest burden, –y_t / (1+y_t)d_t-1 is
the effect of nominal GDP growth (and the sum of the two terms is the infamous
snowball effect[1] of public debt), sp_t^cyc is
the cyclical component of the primary budget balance (excluding the interest
burden), sp_t^struc is
the structural primary balance (adjusted for the output gap) and afs_t represents
the stock-flow adjustments, i.e. transactions on the assets and liabilities of
general government that are not accounted for in the primary balance.

By aggregating each of these terms, we calculate
the contributions to the total change in public debt between 1999 and 2019
(Figure 2) and year by year (Figure 3). Finally, Figures 4A and 4B present breakdowns
of the public debt similar to Figure 2 but over two sub-periods: 1999-2008 and
2008-2019.

The scars of the double recession of 2008-2010 and
2011-2013 in the euro zone

The rise in public debt in the EMU is largely
explained by the cyclical effects of the double recession of 2008-2010 and
2011-2013 (Figure 3). Between 2008 and 2019, in the three countries with the
largest increases in public debt (Greece, Spain, Portugal), the rise in debt is
due largely to cyclical primary deficits and the snowball effect. Greece is a
striking example: the snowball effect accounts for almost 3/5 of the increase
in public debt between 1999 and 2019, and this is concentrated mainly between
2008 and 2019, with the collapse of the level of GDP. In contrast, the apparent
Irish “miracle” is actually due to massive nominal growth in 2015, which in
turn is explained by the relocation of existing intangible assets in
Ireland by multinationals.

Moreover, any positive contribution of structural deficits to debt growth during the 2008-2010
crisis is in fact an optimal countercyclical response of fiscal policy during
the recession, and cannot be interpreted as a lack of fiscal seriousness per
se. This was the case, however, in fewer than half of the countries
studied: Spain, the Netherlands, France, Austria, and Ireland, and for the
other countries this largely reflects the pro-cyclical character of
discretionary fiscal policies in the euro zone over the period (Aldama and Creel, 2020).

Finally, in general, the contribution of the stock-flow
adjustments increases sharply after the 2008 crisis, mainly due to the banking
sector rescue plan. In the case of Greece, the negative contribution of these
adjustments largely corresponds to the 2012 default.

Northern surpluses vs. Southernstructural
deficits in the euro zone?

Over the period 1999-2019, it appears that only
three countries (France, Ireland and Portugal) showed a positive contribution
of structural primary deficits to the rise in public debt. Remarkably, both
Greece and Italy stand out from these countries with a negative contribution
due to their structural primary surpluses, as shall be seen later, due in
particular to the structural fiscal adjustment carried out since 2010 in the
case of Greece. Belgium, which was heavily indebted at the time of its entry
into the EMU (114% of GDP), is also characterised by the strong negative
contribution of its structural primary balance to debt growth.

In the case of Greece, we observe in particular the
sharp decline in the contribution of the structural primary balance, which even
becomes negative in 2019: in other words, by 2010 Greece has more than offset
the effect of its previous structural primary deficits. Even more remarkably,
Italy has pursued a very tight fiscal policy over the entire period, in so far as the (negative) contribution
of its structural primary surplus has steadily increased in absolute terms.
Portugal lies in between, and started to run structural primary surpluses,
without cancelling out the effect of its pre-2010 deficits. Ireland, sometimes
presented as the “good pupil” in the euro area following the 2010
crisis, did not have post-crisis structural surpluses that offset the
structural deficits run up during the crisis (the contribution to the change in
debt was stable).

Focusing on the pre-2008 period (Figure 4A) and the
so-called Southern countries, again only Greece and Portugal saw a positive
contribution of their structural deficits to debt growth, while the
contribution of the primary structural surpluses in Ireland, Italy and Spain was
negative.

On the Franco-German side, the divergence is clear.
German fiscal rigour appears almost extreme: even following the 2008-2010
crisis, the federal government’s primary structural balance did not contribute
positively to debt growth, reflecting a very weak countercyclical discretionary
policy (the German structural balance increased by 1 GDP point in 2010).
Conversely, in the case of France, a large part of the variation in public debt
can be explained by the structural deficits recorded both
before and after 2008 (Figures 4A and 4B), although this slowed down
in the second half of the 2010s (Figure 3). Thus, of the 37 GDP points of
public debt accumulated since 1999, almost 26 points came from structural
deficits accumulated over the period.

Of course, the distinction between the structural balance
and the cyclical balance is critically based on the estimation of the level of
“potential” GDP, i.e. of full utilization of production factors,
without inflationary pressures. This measure is subject to great uncertainty,
and there have been many criticisms, such as that it is too sensitive to the
macroeconomic cycle and to demand shocks (Coibion et al. 2018; Fatas and Summers 2018). Some studies suggest that the level of potential
activity may be underestimated. This likely bias in potential GDP estimates points
to the need for a note of caution about any definitive interpretation of the
structural vs. cyclical nature of budget deficits or surpluses. [2]

***

While public debt has increased overall in the euro
zone since 1999, a large part of this growth is explained by the direct and
indirect consequences of the 2008 crisis, through cyclical deficits, the
aggravation of the snowball effect and the structural weakness
of growth in certain Southern European countries.

On the contrary, most of the more indebted
countries today ran high primary structural surpluses over the period, such as
Italy and Belgium. Greece has even more than offset the positive contribution
of its past structural deficits. This is the reason why a reading grid that is
still overly used, that of the North versus the South, or of fiscal strictness versus
fiscal leniency, cannot stand up to a simple accounting analysis of the
dynamics of public debt.

[1] The snowball effect of public debt is the effect of the differential between the interest rate paid on the accumulated stock of debt and the economy’s growth rate. If this differential is positive, then for a given primary budget balance public debt tends to increase mechanically; conversely, if it is negative, public debt tends to decrease mechanically.

2] However, using the OECD Economic Outlook
has the advantage of providing a homogeneous approach across countries, and
therefore a relatively uniform bias between them. Moreover, the measure of
potential GDP used by the OECD is less cyclical than the measures used by the IMF and
the European Commission.

Christophe Blot, Caroline Bozou and Jérôme Creel

In a recent Monetary
Dialogue Paper for the European Parliament, we review
and assess the different policy measures introduced by the ECB since the
inception of the COVID-19 crisis in Europe, mainly the extension of Asset
Purchase Programme (APP) measures and the development of Pandemic Emergency
Purchase Programme (PEPP) measures.

APP and PEPP have had distinct
objectives in comparison with former policies. APP has
been oriented towards price stability while PEPP has been oriented towards the
mitigation of financial fragmentation.

To this end, we start by analysing the effects of APP announcements
(including asset purchase flows) on inflation expectations via an event-study
approach. We show that they have helped steer expectations upward.

Then, we analyse the impact of PEPP on sovereign spreads and show that
PEPP has had heterogeneous effects that have alleviated fragmentation risk:
PEPP has had an impact on the sovereign spreads of the most fragile economies
during the pandemic (e.g. Italy) and no impact on the least fragile (e.g. the
Netherlands). However, sovereign spreads have not completely vanished, making
monetary policy transmission not fully homogeneous across countries.

On a broader perspective, we also show that overall macroeconomic
effects have been in line with expected outcomes since the mid-2000s: ECB
monetary policy measures have had real effects on euro area unemployment rates,
nominal effects on inflation rates and financial effects on banking stability. These
results are in line with recent estimates at Banque de France (Lhuissier
and Nguyen, 2021).

As a conclusion, an increase in the size of the PEPP program, as
recently decided by the ECB, will be useful if financial risks re-emerge.
Meanwhile, we argue that an ECB decision to cap the sovereign spreads during
the COVID-19 crisis would alleviate the crisis burden on the most fragile
economies in the euro area, where sovereign spreads remain the highest.

by Christine Rifflart

Spain has been hit hard in 2020 by the Covid-19 health
crisis, which the authorities are struggling to control, accompanied by an
economic recession that is one of the most violent in the world (GDP fell by
11% over the year according to the INE)[1]. The country’s unemployment rate reached 16.1% at
the end of last year, a rise of 2.3 points over the year despite the
implementation of short-time work measures. The public deficit could exceed 10%
of GDP in 2020, and the public debt could approach 120% according to the Bank
of Spain’s January 2021 forecasts. Europe has enacted large-scale support programmes
for affected countries, and as one of these Spain will be the country receiving
the most EU-level aid. It will benefit from at least 140 billion euros, with 80 billion
of that (i.e. 6.4% of 2019 GDP) taking the form of direct transfers through the
NextGenerationEU programme.

This aid is arriving in a very particular political
context, marked by the progressive aspirations of a coalition government
(PSOE-Unidas / Podemos) that has governed for just over a year, and which still
appears to be solid. The commitments made in December 2019 between the two
parties in a joint Pact entitled ”Coalicion Progresista –
Un nuevo acuerdo para Espana” [Progressive
Coalition – A New Agenda for Spain] have now been included in the recovery plan
sent to the EU Commission, and the first measures of the planned reforms have
been included in the 2021 budget. In this difficult health and economic
situation, the Spanish government could seize the opportunity provided by this
crisis to carry out a thorough restructuring of the country with the help of
European funds and push through some of the social reforms announced in the
PSOE-UP Pact. The needs, it must be said, are great. In 2018, the poverty rate
was 19.3% among young people and 10.2% among those over 65 (compared with 11.7%
and 4.2% respectively in France). Even though annual growth averaged close to
3% over the period 2015-2019, Spain’s unemployment rate has remained at a very
high level (14.1% in 2019), and labour productivity is still almost 25% lower
than in France. There are significant regional disparities and insufficient investment,
particularly public investment. But Spain could turn the corner over the next
few years. The measures announced are commensurate with the government’s
ambitious aspirations for growth, employment, and social equity. The greater risk
is probably to the government’s solidity and its political capacity to
implement it.

The 2021 budget, the first since July 2018!

Spain has gone two years without a budget vote, as
the 2018 budget was extended twice after being amended by government decrees. But
the government has finally managed to provide itself with a 2021 budget while
impeccably respecting the timetable it had set out. The budget was sent to Brussels
on 10 October 2020, approved on 3 December by the Congress of Deputies (Spain’s
lower chamber), and on 22 December by the Senate, and so was adopted in less
than three months. However, nothing can be taken for granted. The latest legislative
elections in November 2019 (the fourth in four years) failed to give an
absolute majority in Parliament to the socialist party PSOE, or even to the leading
two parties combined (i.e. PSOE-UP, 155 deputies out of 350). So Pedro
Sanchez’s coalition government was compelled to seek the support of the small
pro-independence and regionalist parties for the adoption of its budget. After
three months of negotiations and several thousand amendments, a large majority
was obtained. Of the 350 deputies in Congress, 188 from 11 different political
formations voted in favour (155 from PSOE-UP, 13 from the ERC and 6 from the
PNV). It must be said that a political failure would have been very unwelcome
given the great needs and expectations and the favourable opportunities.

European funding to carry out the modernization of Spain’s
production infrastructure, as set out in the PSOE-UP Pact of December 2019

According to Spain’s Finance Minister [2], the country is expected to receive 79.8 billion
euros in European subsidies over the period 2021-2023 under the NextGenerationEU programme. This is over 10 billion
more than the amount announced by the Commission in the spring of 2020 (69.4
billion, a revision of +14.9%), as the 2020 growth forecasts made last autumn were
more pessimistic than those made six months earlier, and due to converting the initial
funding from 2018 prices to current prices. The revision concerns the
allocation of the Recovery and Resilience Facility (RRF), which has increased
from 59.2 billion euros to 69.5 billion, with the grant under the REACT EUprogramme remaining at 10.3 billion. Spain is
thus now the largest recipient of EU funds, ahead of Italy, which is to receive
79.6 billion (up from 76.1 billion initially announced), i.e. 4.4% of its 2019
GDP, 2 points less than Spain. Seventy percent of this allocation is guaranteed
for 2021-2022 (46.6 billion) [3]. The balance over 2023 will have to be reassessed
in June 2022, depending on the economic situation and the state of public
finances in the light of the Stability and Growth Pact rules, which are likely
to be restored by that date.

In order to benefit from European funds, Spain,
like all its partners, has to present its National Plan for Recovery,
Transformation and Resilience, which aims to stimulate short-term growth
through investment and consumption [4],
and to promote a “more sustainable, more resilient economy that
is prepared for the challenges ahead”,in thewords
of the Commission. Ultimately, the government’s objective is to raise potential
growth by 0.4-0.5 percentage points to over 2% per year by 2030.

While Spain traditionally has a low rate of
absorption of European funds, this time the government wishes to speed up the
process greatly. So on 20 January (with a deadline set for 30 April), the
government submitted to Brussels the 30 files in its Recovery plan presenting
the investment projects and the guidelines for the reforms envisaged in the
areas of taxation, the labour market, and pensions, which are intended to
ensure the country’s transition. It even foresees anticipating the release of
the RRF funds (scheduled after the Commission examines the Recovery plan for two
months) by financing the investments with debt. It must be acknowledged that
the needs are immense in Spain’s production system, which is marked by the
importance of SMEs. At the end of 2019, 53.5% of businesses were made up of the
self-employed, 40% had between 1 and 9 employees, and 5.5% had between 10
and 49 employees, in total accounting for half of all jobs. According to the
government’s intentions:

• 37% of the funds are earmarked for the ecological transition
  (250,000 new vehicles purchased by 2023, installation of 100,000 charging
  stations, transformation of the electrical system to 100% renewable energy
  by 2050, and the renovation of more than 500,000 homes for improved energy
  efficiency);
• 34% are for the digital transformation (with a coverage rate of 80%
  of the population, including 75% by 5G; development of teleworking for
  more than 150,000 public jobs; training for more than 2.5 million SMEs;
  etc.);
• And 30% for Research and Development, education and training, and social
  and territorial inclusion.

The broad outlines of the reforms have also been
drawn up. The new orientation of the tax reform aims at greater progressiveness
and more redistribution [5], and is already included in the 2021 budget (see
below). The reforms concerning the labour market, which is still very dual, and
pensions have not yet been discussed in Parliament or with the social partners,
so they are still at the stage of principles, which should, nevertheless,
satisfy Brussels. As regards labour market reform, the main measures presented
aim at generalizing the use of open-ended contracts and tightening up on the
use of fixed-term contracts; strengthening the use of flexible working time as
an alternative to fixed-term contracts and redundancies; the modification of active
employment policies; calling into question the 2012 reform on collective
bargaining; an employment programme targeted at young people (2021-2027); and modernizing
the public employment service (SEPE). The pension reform is less advanced and
is giving rise to greater tension between the partners. For example, in the
plan sent to Brussels the government did not include its proposal to increase
the contribution period for calculating pensions from 25 to 35 years.

Above all, however, Spain’s National
Plan for Recovery, Transformation and Resiliencepresented to the
European Commission, which should lead to the disbursement of European funds,
is fully in line with the Coalicion  Progresista – Un nuevo acuerdo para Espana Pact signed in December 2019 between the two ruling
coalition parties PSOE and UP-Podemos. The document’s initial sections stress
the importance of investing in the digital transformation, the ecological
transition, and R&D and training to modernize Spain’s economy and create
quality jobs. The European grants provide the left-wing government with a giant
opportunity to finance this project to transform Spain’s productive infrastructure.

Higher taxation to finance the social measures
included in the Pact

In addition to the investment projects included in
the recovery plan and financed by European funds, in its 2021 budget the
government launched the tax reform presented in the Pact, which is intended to
finance the social measures planned or already taken. As mentioned above, the
absence of a majority in the Congress of Deputies and the Senate has opened the
way for negotiations with the small pro-independence and regionalist parties,
and thus for concessions to obtain support. Not all the measures were approved [6]. Ultimately, the reform should bring in 7.7
billion euros [7], 1.4 billion less than what was set out in the budget
bill sent to Brussels. If we add the cost of maintaining VAT on surgical masks
at 0%, the shortfall to meet the deficit commitment comes to 3 billion euros.

The 2021 tax reform mainly focuses on large corporations
and high income earners. It includes:

• Reducing
  the corporate tax exemption on dividends and capital gains received from foreign
  subsidiaries from 100% to 95%. So
  now the 5% not exempted is taxed at the general rate of 25% (30% in the
  case of banks and oil companies). This measure excludes SMEs (companies
  with a turnover of less than 40 million) for three years (expected gain of
  1,520 million euros). In addition, the State has introduced a minimum tax
  on listed real estate investment companies (SOCIMIs) of 15% (+25 million
  euros);
• A
  2-point increase in personal income tax (IRPP) on income over €300,000 and 3 points on
  savings income over €200,000 (raising the rate from 23% to 26%) (a total gain
  of €490 million). This measure affects the 36,200 individuals with the
  highest incomes (i.e. according to the Ministry, 0.07% of contributors) [8];
• A reduction from 8,000 to 2,000 euros in the IRPP exemption
  threshold for individual investments in private pension funds (+580
  million) and an increase from 8,000 to 10,000 euros in the incentive
  threshold for companies;
• The tax on insurance premiums has been increased from 6% to 8%
  (+507 million);
• An increase in VAT on sugary and
  sweetened drinks, excluding dairy products, from 10 to 21%
  (expected gain of 360 million);
• The introduction of a 0.2% financial transaction tax for
  corporations with a capital of more than €1 billion (Tobin tax) anda 3% tax
  on the digital economy (GAFA tax).
  These taxes should bring in €850 million and €968 million respectively.
  Adopted in 2020, they came into force on 16 January;
• A green tax is being introduced with the creation of
  a tax on single-use plastics (+491 million) along with other measures (tax
  on waste, etc.) (+861 million);
• Lastly, measures to combat tax fraud are being
  taken, with an expected gain of 828 million.

This additional tax revenue is intended to cover
social expenditure, in particular the Minimum Living Income introduced
in June 2020 to reduce poverty and promote labour market integration. This will
affect around 850,000 families (2.3 million people, 17% of the population). The
amount of support ranges from 462 euros per month for a person living alone to
1,015 for a family. The pensions and salaries of civil servants will be increased
by 0.9%, non-contributory benefits by 1.8%, and the reference indicator used to
determine eligibility for many social benefits (IPREM) by 5% (it has been
frozen since 2017). The other flagship measure concerns dependency support, with anadditional
600 million, and education. On the other hand, the goal
of raising the minimum wage (SMI) to 60% of the average wage by the end of the
legislature (to between €1100 and €1200 per month in 2023) has been temporarily
suspended. After a 20% increase in 2020, the SMI therefore remains at €950 per
month for 14 months. The salaries of members of the executive have been frozen
this year.

After long years of political instability, it is to
be hoped that, despite the difficult context, the current coalition government
will be able to continue to find a basis for agreement within the different
Spanish political formations in order to take advantage of the favourable
opportunities and open up new and constructive perspectives.

[1]  For a more detailed analysis of the crisis, please
refer to the OFCE Policy Brief by Hervé Péléraux and Sabine Le
Bayon: “Croissance mondiale confinée en 2020”, no. 82 of 14 January
2021.

[2] The
information must be approved by the European Parliament in the coming weeks.

[3] The distribution of these new amounts over
2021 and 2022 is not available. We do know, however, that of the 69.437 billion
initially planned for the period 2021-2023, the State was to receive 26.634
billion in 2021, including 2.436 billion from the REACT EUfund for
the purchase of vaccines. Out of the 26.634 billion received, the State is to disburse
10.8 billion to the regions, which are also to receive 8 billion REACT EU funds to strengthen their health and education systems.

[4] On the basis of an average multiplier of 1.2,
in the budget bill sent to Brussels the government estimated the impact of the
recovery plan on growth at 2.5 points in 2021. Under less favourable hypotheses
(the rather slow rate of absorption of past European funds, complexity in
management at the regional level, etc.), in January 2021 the Bank of Spain
estimated the impact at between 1 and 1.6 points.

[5] According to the OECD, in 2018, the ratio
between the average income of the richest 20% and the poorest 20% was 5.9 in
Spain, compared to 4.6 in France.

[6] Thus, the tax increase on private educational
and health institutions was rejected before it was even presented to the
Congress of Deputies, and the tax increase on diesel (+3.8 cents per litre to
34.5 cents, compared to 40.07 on petrol) had to be abandoned. These measures
were expected to bring in 967 and 500 million euros respectively.

[7] Using the cash concept, the revenue changes from
6.847 billion to 5.635 billion in 2021 and from 2.323 billion to 2.135 billion
in 2022.

[8] This measure reflects a fairly marked retreat
from the Pact’s commitments. Indeed, the IRPP was expected to increase by 2
points on income > €130,000, by 4 points on income > €300,000, and by 4
points on savings income > €140,000. An increase of 1 point in the wealth
tax was included for assets over €10 million.

By Christophe Blot and Paul Hubert

In response to the health and economic crisis,
governments have implemented numerous emergency measures that have pushed public
debt up steeply. They have nevertheless not experienced any real difficulty in
financing these massive new issues: despite record levels of public debt, the
cost has fallen sharply (see Plus ou moins de
dette publique en France ?, by Xavier
Ragot). This trend is the result of
structural factors related to an abundance of savings globally and to strong
demand for secure liquid assets, characteristics that are generally met by
government securities. The trend is also related to the securities purchasing programmes
of the central banks, which have been stepped up since the outbreak of the
pandemic. For the year 2020 as a whole, the European Central Bank acquired
nearly 800 billion euros worth of securities issued by the governments of the
euro zone countries. In these circumstances, the central banks are holding an
increasingly high fraction of the debt stock, leading to a de facto
coordination of monetary and fiscal policies.

Back in 2009, central banks launched asset purchase
programmes to reinforce the expansionary impact of monetary policy in a context
where the banks’ key interest rates had reached a level close to 0%[1]. The stated objective was mainly to ease financing
conditions by holding down long-term interest rates on the markets. This
resulted in a sharp increase in the size of the banks’ balance sheets, which
now represents more than 53 GDP points in the euro zone and 35 points in
the United States, with the record being held by the Bank of Japan, at 133 GDP points
(Figure 1). These programmes, financed by issuing reserves, have focused heavily on government securities,
meaning that a large proportion of the stock of government debt is now held by
central banks (Figure 2). This proportion reaches 43% in Japan, 22% in the
United States and 25% in the euro zone. In the euro zone, in the absence of
euro bonds, the distribution of securities purchases depends on the share of
each national central bank in the ECB’s capital. The ECB’s distribution key stipulates
that the purchases are to be made pro rata to the share of the ECB’s capital
held by the national central banks[2]. Consequently, the purchases of securities are
independent of the levels and trajectories of public debt. As the latter are
heterogeneous, there are differences in the share of public debt held by the
national central banks [3]. Thus, 31% of Germany’s public debt is held by the
Eurosystem compared to 20% of Italy’s public debt.

The decentralization of fiscal policies in the euro zone is also leading to tensions in the sovereign debt markets of some member countries, as seen between 2010 and 2012 and more recently in March 2020. This is why Christine Lagarde has launched a new asset purchase programme called the Pandemic emergency purchase programme (PEPP). While the distribution key is not formally abolished, it may be applied more flexibly in order to allow the ECB to reduce the sovereign spreads between member countries. Analysing the flows of securities purchases made by the euro zone central banks and the debt issues of the member states, it can be seen that the Eurosystem has absorbed on average 72% of the public debt issued in 2020, i.e. 830 billion euros out of the 1155 billion of additional public debt. The share amounts to 76% for Spain, 73% for France, 70% for Italy and 66% for Germany (Figure 3).

Unlike purchases made under the APP programme,
which aim to hit the inflation target, the PEPP’s objective is first and
foremost to limit rate spreads, as Christine Lagarde reminded us on 16 July 2020.
In fact, even if there is a structural downward trend in interest rates, some
markets may be exposed to pressure. The euro zone countries are all the more
exposed as investors can arbitrate between the different markets without incurring
any exchange rate risks. This is why they may prefer German securities to
Italian securities, thereby undermining the homogeneous transmission of
monetary policy within the euro zone. In addition to arguments about the risk
of fragmentation, these operations also reflect a form of implicit coordination
between the single monetary policy and fiscal policies, providing countries
with the manoeuvring room needed to take the measures required to deal with the
health and economic crisis. By declaring on 10 December that the allocation
to the programme would increase to 1850 billion euros by no later than March
2022, the ECB sent a signal that it would maintain its support throughout the
duration of the pandemic[4].

[1] This policy, generally referred to as
quantitative easing (QE), was launched in March 2009 by the Bank of England and
the US Federal Reserve. Japan had already initiated this type of so-called
unconventional measure between 2001 and 2006, and resumed this approach in
October 2010. As for the ECB, the first purchases of securities targeted at
certain countries in crisis were made from May 2010. But it was not until March
2015 that a QE programme comparable to those implemented by the other major
central banks was developed.

[2] In practice, this share is relatively close
to the weight of each member country’s GDP in euro zone GDP.

[3] Securities purchasing operations are
decentralized at the level of the national central banks. Doing this reduces
risk-sharing within the Eurosystem since any losses would be borne by the
national central banks, unlike assets held directly by the ECB, for which there
is risk-sharing that depends on the share of each national central bank in the
ECB’s capital.

[4] The initial allocation was 750 billion euros,
which was increased in June 2020 by a further 600 billion. As of 31 December 2020,
securities purchases under the PEPP came to 650 billion.

By Christophe Blot

As with the economic performance of all the industrialized
countries, economic activity fell off sharply in the second quarter of 2020
across the Atlantic before rebounding just as sharply the following quarter. The
management of the crisis in the US is largely in the hands of the different States,
and the election of Joe Biden should not change this framework since he
declared on November 19 that he would not order a national lockdown. However,
the health situation is continuing to deteriorate, with more than 200,000 new Covid-19
cases per day on average since the beginning of December. As a result, many
States are adopting more restrictive prophylactic measures, although without returning
to a lockdown like the one in the Spring. This situation could dampen economic prospects
for the end of the year and also for the start of the mandate of the new
President elected in November. Above all, it makes it even more necessary to
implement a new recovery plan, which was delayed by the election.

As in the euro zone, recovery in the US kicked off as
soon as the lockdown was lifted. GDP grew by 7.4% in the third quarter after
falling by 9% in the previous quarter. Compared with the level of activity at
the end of 2019, the economic downturn amounted to 3.5 points, versus 4.4
points in the euro zone. The labour market situation also improved rapidly,
with the unemployment rate falling by 8 points, according to data from the Bureau
of Labor Statistics for November, from its April peak of 14.7%. These results
are the logical consequence of the lifting of restrictions but also of the large-scale
stimulus plans approved in March and April, which have massively absorbed the
loss of income for households and to a lesser extent for US companies (see here).
However, the upturn in consumption is still being dampened by some ongoing restrictions,
particularly in sectors with strong social interactions, where spending is
still nearly 25% lower than it was in the fourth quarter of 2019 (Figure 1).
As for the consumption of goods, it has been much less
affected by the crisis and is down only 12% from its pre-crisis level for
durable goods and 4.4% for non-durable goods. Nevertheless, most of these
support measures have come to an end, and as of this writing the discussions
that began in late summer in Congress have not yet led to an agreement between
Republicans and Democrats. Despite the rebound, the health impact of the pandemic
and the economic consequences of the lockdown on the labour market require a discretionary
policy in a country where the automatic stabilizers are generally considered to
be weaker[1]. New support measures will be all the more
necessary as a further tightening of restrictions is looming and the recovery
seem to be running out of steam. The initial consumption figures for the month
of October point to a fall in the consumption of services, and employment also
stabilized in November, remaining well below its level at the end of 2019.

However, after the setback of the discussions in
Congress, it will now be necessary to wait until the first quarter of 2021 for
a new support plan to be approved and for a possible reorientation of US fiscal
policy after Joe Biden’s victory. In the Autumn, the Democrats proposed a 2
trillion dollar (9.5 GDP points) package, almost as much as the 2.4 trillion dollar
(10.6 GDP points) package adopted in March-April 2020[2]. The aid would, among other things, support the
purchasing power of the unemployed through an additional federal payment.
Although unemployment is much lower than in the second quarter, it remains
above its pre-crisis level and is now characterized by an increase in long-term
unemployment for which there is generally no compensation. In November, the
share of those who had been unemployed for at least 27 weeks was 37 per cent
(or 3.9 million people, Figure 2), and the median duration of unemployment
had risen from 9 weeks at the end of 2019 to almost 19 weeks in November 2020.
In addition, States whose tax revenues have decreased with the crisis could
benefit from a federal transfer, thereby avoiding spending cuts[3].

However, despite the end of the suspense over the
outcome of the presidential elections, the political and economic uncertainty
has not been completely resolved. Indeed, it will not be known until early
January whether the Democrats will also have a majority in Congress. They have
certainly kept the House of Representatives, but it will be necessary to wait
until the beginning of January for the Senate, with a ballot planned in Georgia
that will determine the political colour of the last two seats [4]. Both seats are now held by Republican senators.
However, Joe Biden won Georgia by 0.2 points against Donald Trump, the first
victory in the State for a Democratic candidate since 1992. With both State-wide
senatorial elections to be contested directly, the results are likely to be
close.  If one of the Democratic
candidates is defeated, Joe Biden will be forced to contend with the
opposition. But, as Paul Krugman
points out, the Republicans are generally more inclined, once in opposition, to
promote austerity. This is reflected in the uncertainty indicators of Bloom,
Baker and Davies, whose economic policy uncertainty rose in November (Figure 3).
This uncertainty is certainly lower than in the Spring but remains higher than
that observed between 2016 and 2019. During this period, growth could weaken,
and then a strong recovery is likely to be followed by more subdued growth,
which will have repercussions on the labour market. Regardless of the outcome,
a plan will likely be approved in the first quarter of 2021, but its adoption
could take longer if it is conditional on an agreement between Republicans and
Democrats in Congress. However, this could be lengthy given the urgency of the
health and social crisis, and could plunge a significant proportion of the most
vulnerable into poverty.

Source : Baker, Bloom & Davis. https://www.policyuncertainty.com/index.html

[1] See for example Dolls, M., Fuest, C. &
Peichl, A., 2012, “Automatic stabilizers and economic crisis: US vs. Europe”, Journal of Public Economics,
96(3-4), pp. 279-294.

[2] By comparison, the
European programmes are weaker, ranging from 2.6 GDP points for France to 7.2
points for the UK.

[3] Note that the States generally have fiscal
rules limiting their capacity to run a deficit.

[4] Of the 100 seats in the Senate, the
Republicans already hold 50. In the event of a tie between the two parties, it
is the voice of the Vice-President-elect Kamala Harris that will decide between
them. A single victory in Georgia would therefore allow the Republicans to
retain the majority.

By Christophe Blot, Magali Dauvin and Raul Sampognaro

The sharp fall in activity and its brutal social consequences have led governments and central banks to enact ambitious support measures to cushion the shock, which resulted in an unprecedented global recession in the first half of 2020, as discussed in Policy Brief 78 . Faced with a health crisis that is unprecedented in contemporary history, requiring forced shutdowns to curb the spread of the virus, governments have taken urgent measures to prevent the onset of an uncontrolled crisis that could permanently alter the economic trajectory. Three main types of measures have been taken: some aim to maintain consumer purchasing power in the face of the shutdowns; others seek to preserve the production system by targeting business; and some are specific to the health sector. The quarterly national accounts, available at the end of the first half of the year, provide an update on the extent to which the disposable income of private agents has been preserved by fiscal policy at this stage of the Covid-19 crisis [2].

Fiscal policy has shot up Americans’ household
income and preserved Europeans’ income

In the major advanced economies, the Covid-19
crisis generated losses in primary income (before cash transfers) ranging from 81
billion pounds in the United Kingdom to 458 billion dollars in the United
States (Table 1). The initial income shock was thus larger in Spain and Italy –
6.5 and 6.7 GDP points respectively – and smaller in Germany (3.4 GDP points)
and the United States (2.1 GDP points).

Figure 1 breaks down the share of the primary income (PI) shock received by agents (first bar on the left for each country, labelled “PI”). In Spain and Italy, households suffered the majority of the losses, accounting for 54 percent and 60 percent, respectively, of the total income loss for the economy. In France and Germany, enterprises bore the lion’s share  of the income loss (48%). In the United Kingdom and the United States, enterprises incurred losses of £50 billion and $275 billion, respectively, accounting for 62% and 60% of the total loss for the economy. General government (GG) experienced a smaller shock in all the countries, which is explained by the spontaneous changes in some of the automatic stabilizers, and by a relatively lower value added due to the restrictions on activity during lockdowns.

Turning to the breakdown in losses in disposable
income (DI), which takes into account cash transfers, social contributions, and
income tax, the story is rather different. The implementation of emergency
measures made it possible to absorb some of these losses, as illustrated by the
bar labelled “DI” in Figure 1. The introduction of short-time working
in European countries thus shifted the burden of wages from enterprises to the
government, thus preserving household incomes and avoiding the termination of job
contracts. Similarly, reductions in social contributions and tax on income and
corporate profits have shifted the cost of the crisis from private agents to
government. In the face of the unforeseeable shock, the State has thus played
the role of insurer of last resort of private agent income, although to
different extents in different countries. Thus, while Spain’s government absorbed
13.5 percent of the primary income shock, support measures raised this share to
59 percent, a higher level than that of Italy (55.3 percent) and France (54.3
percent) in terms of disposable income. In comparison, the measures taken by
the German government absorbed a higher share of the shock, amounting to 67
percent of the loss of disposable income, compared with 28 percent of the fall in
primary income.

In the United Kingdom, emergency measures absorbed
the entirety of the shock. While business and households suffered primary
income losses of £50 billion and £15 billion respectively, their disposable
income fell by only £4 billion and £2 billion. As for disposable income,
government absorbed 93.6 percent of the shock. The contrast is even more marked
in Germany and the United States, where measures overcompensated the initial
primary income shock, especially for households. The US figures are
particularly impressive. Over the six-month period, primary income fell by $192
billion, while household disposable income rose by $576 billion, due in
particular to the payment of a tax credit and an exceptional federal
unemployment benefit of $600 per week that was paid to the unemployed,
regardless of their initial income[3]. The various tax measures and subsidies to
business reduced the loss by $210 billion. The US government thus absorbed 237
per cent of the shock, reflecting the magnitude of the support measures taken
in March-April.

Job losses and uncertainty about the future may
hamper recovery across the Atlantic

As we have seen, fiscal policy has been mobilized
massively across the Atlantic. Even if at this stage the macroeconomic shock has
been weaker in the US than in the EU[4], the fiscal impulse is much larger. At the end of
the first half-year, total transfers to households exceeded the immediate shock
to their primary income. This has led to a 13% increase in the disposable
income of US households, at the same time as their primary income fell by 4% in
connection with job destruction. This situation is due in particular to a tax credit
paid to households and an additional lump-sum allowance of $600 per week paid
by the federal government to any person eligible for unemployment. Between Q4 of
2019 and Q2 of 2020, transfers to households leapt by 80%, now representing 31%
of disposable income compared with 19% in 2019.

This difference in crisis management is undoubtedly
explained by the weakness of the social safety net in the United States, which
effectively reduces the role of automatic stabilizers while also limiting the
ability of citizens with little or no health insurance coverage to meet health
care expenses in the event of a fall in income. The use of counter-cyclical
measures is thus of greater importance, which probably explains why the
stimulus packages are more extensive than they were during the 2008-2009 crisis
as well as why the measures provide direct, substantial support to household
income. Moreover, in the US, the federal government is responsible for this
stimulus, while in the EU, the bulk of the support plans come from the Member states.

The sharp rise in unemployment across the Atlantic
– which peaked at 14.7% in April – contrasts with the situation in Europe,
partly due to the differentiated strategy in economic policy. The United States carried out a positive, substantial
transfer of income to households to offset the fall in wages resulting from job
losses, which also helped to mitigate the shock on business margins.
Conversely, in the main European economies, contractual employment
relationships were maintained, but household incomes were not preserved quite
as much – they actually fell slightly, except in Germany. In the main European
economies, a decision was taken to use short-time working on a massive scale, while
in the United States the response was to send cheques directly and immediately
to households.

This situation, where income was propped up during
a period when consumption was curtailed by the closure of non-essential shops, led
to the accumulation of 76 billion euros in “Covid savings” in Germany
(8 GDI points), 62 billion in France (9 GDI points) and 38 billion in Spain and
Italy (10 and 6 GDI points respectively). In the United Kingdom and the United
States, “Covid savings” were even greater: £89 billion in the UK (12 GDI
points), while the sum reached $961 billion in the US (12 GDI points). How the
epidemic develops and how these savings are used will be the two keys
determining the extent of the rebound in activity starting in the second half
of 2020.

This is precisely the moment when differences in
approach can create divergences in economic trajectories. While it could be
said that up to now household situations have been better preserved across the
Atlantic, job contracts have been shredded. In this context, it may take some
time to get the workforce back into employment, hindering the rapid
redeployment of the production base. This could slow down the speed at which activity
returns to normal, helping to keep job losses up and limiting the restoration
of company balance sheets. Furthermore, negotiations between Democrats and
Republicans in Congress have hit the wall of the approaching November 3
elections. If the measures taken during the crisis are not – at least partially
– renewed, the situation of American households is likely to become more
critical, since weak US social safety nets will not be able to mitigate what
threatens to be a long-term shock. This may have second-round effects on
primary income and investment [5]. Following the elections, further measures are
likely to be taken, but the time lag could be long, especially if Joe Biden
wins, as he will have to wait until he takes office in January 2021. Continued
high uncertainty about the extent of the recovery – accentuated by political
uncertainty – may encourage American households to avoid spending “Covid
savings” in order to have “precautionary savings” to face a probable
long-term health, economic and social crisis.

Glossary

Primary income (PI): Primary income includes revenue directly related
to participation in the production process. The bulk of primary household
income consists of wages, salaries and property income.

Gross disposable income (GDI): Income available to agents to consume or invest,
after redistribution operations. This includes primary income plus social cash
benefits and minus social contributions and taxes paid.

* * *

[1] See “Evaluation de la pandémie de Covid-19 sur
l’économie mondiale” [Evaluation
of the Covid-19 pandemic on the world economy], Revue de l’OFCE no. 166 for
an initial analysis of the various fiscal and monetary support measures
implemented.

[2] These results should be taken with a grain of
salt. While the quarterly national accounts are the most comprehensive,
consistent framework available, with data collected by official statistics
institutes, they are nevertheless provisional. These accounts are subject to
significant revisions that may significantly alter the final results when they
incorporate new data (company balance sheets, etc.); they are considered final
within two years.

[3] This allowance is in addition to that paid by
State-run unemployment insurance systems.

[4] The loss in 6-month GDP was 5% in the US,
compared with 8.3% in the EU.

[5] F. Buera, R. Fattal-Jaef, H. Hopenhayn, A.
Neumeyer, and J. Shin (2020), “The Economic Ripple Effects of COVID-19”, Working Paper.

By Christophe Blot and Paul Hubert

The return of new lockdown measures in numerous countries
is expected to slow the pace of economic recovery and even lead to another
downturn in activity towards the end of the year. To address this risk,
governments are announcing new support measures that in some cases supplement
the stimulus plans enacted in the autumn. No additional monetary policy
measures have yet been announced. But with rates close to or at 0% and with a
massive bond purchase policy, one wonders whether the central banks still have any
manoeuvring room. In practice, they could continue QE programmes and increase
the volume of asset purchases. But other options are also conceivable, such as
monetizing the public debt.

With the Covid-19 crisis, the central banks – the
Federal Reserve, the Bank of England and the ECB – have resumed or amplified
their quantitative easing (QE) policy, to such an extent that some are viewing
this as a de facto monetization of debt. In a recent Policy
Brief, we argue that QE cannot
strictly be considered as the monetization of public debt, in particular
because the purchases of securities are not matched by the issuance of money
but by the issuance of excess reserves. These are distinct from the currency in
circulation in the economy, since they can be used only within the banking
system and are subject to an interest rate (the deposit facility rate in the
case of the euro zone), unlike currency in circulation.

Our analysis therefore makes it possible to look
again at the characteristics of QE and to specify the conditions for monetizing
debt. It should result in (1) a saving of interest paid by the government, (2) the
creation of money, (3) being permanent (or sustainable), and (4) reflect an
implicit change in the objective of the central banks or their inflation
target. The implementation of such a strategy is therefore an option available
to central banks and would allow the financing of expansionary fiscal policies.
The government, in return for a package of fiscal measures – transfers to
households or health care spending, support for businesses – would issue a
zero-coupon perpetual bond, purchased by commercial banks, which would credit
the account of the agents targeted by the support measures. The debt would have
no repayment or interest payment obligations and would then be acquired by the
central bank and retained on its balance sheet.

Monetization would probably be more effective than QE
in stabilizing nominal growth. It would reduce the risk to financial stability caused
by QE, whose effect depends on its transmission to asset prices, which could
create asset-price bubbles or induce private agents to take on excessive debt.
Monetization has often been put off because of fears that it would lead to
higher inflation. In the current environment, expansionary fiscal policy is
needed to sustain activity and to prepare for recovery once the pandemic is
under control. A pick-up in the pace of inflation would also satisfy the central
banks, and insufficient demand should greatly reduce the risk of an out-of-control
inflationary spiral. Monetization requires stronger coordination with fiscal
policy, which makes it more difficult to implement in the euro area.

by Jérôme Creel (OFCE & ESCP Business School) [1]

On 27 May, the European Commission proposed the
creation of a new financial instrument, Next Generation EU,
endowed with 750 billion euros. The plan rests on several pillars, and will notably
be accompanied by a new scheme to promote the revival of activity in the
countries hit hardest by the coronavirus crisis. It comes on top of the
Pandemic Crisis Support adopted by the European Council in April 2020. A new
programme called the Recovery and Resilience Facility will have firepower of 560
billion euros, roughly the same amount as the Pandemic Crisis Support. The
Recovery and Resilience Facility stands out, however, for two reasons: first,
by the fact that part of its budget will go to grants rather than loans; and
second, by its much longer time horizon.

The Pandemic Crisis Support (and the complementary
tools adopted at that time, see Creel, Ragot & Saraceno, 2020) consists exclusively of loans, and the net gains that
the Member States could draw from them are by definition low: European loans
allow a reduction in interest charges for States subject to high interest rates
on the markets. The gain for Italy, which was hurt badly by the coronavirus
crisis, is in the range of 0.04 to 0.08% of its GDP (this is not a typo!).

Under the Recovery and Resilience Facility, the euro
zone Member States would share 193 billion euros in loans and 241 billion euros
in grants, or in total 78% of the amounts allocated (the rest will go to EU states
that are not euro zone members). The loans will generate small net gains for Member
States (savings on the infamous interest rate spreads), while the grants will lead
to larger gains, since they will not be subject to repayment, other than via higher
contributions between 2028 and 2058 to the European budget (if the EU’s own funds
have not been created or increased by then). In the short term, in any case,
the grants received represent net gains for the beneficiaries: they will
neither need to issue debt nor pay interest charges on such debt.

Expressed as a percentage of 2019 GDP, the net
gains from grants are far from negligible (Table 1)[2]: 9 GDP points for Greece, 6 for Portugal, 5 for
Spain and 3.5 for Italy. This will be even more significant given the expected
fall in GDP in 2020. The determination of the Commission is therefore clear.

Despite all this, these grants are not intended to
be used in the short term. The European Commission purportedly wanted the
allocated amounts to be spent as quickly as possible, in 2021, 2022 and in any
case before 2024. This is what it calls “front-loading”: do not put
off till the morrow what can be done today. Except that the key to the
distribution of the grant expenditures over time is somewhat in contradiction
with this principle (Table 2). The grant commitments would be concentrated in
2021 and 2022, but the actual disbursals are planned for later: less than a
quarter by 2023, half in 2023 and 2024, and the remainder after that. This kind
of gap is frequent: it takes a little time to design an investment project and
to ensure that it complies with the European Commission’s digital ambitions and
low-carbon economy.

As a result, the grants to the Member States will
take a little time to actually be disbursed (Table 3), and the countries facing
the greatest difficulties will have to be resilient before receiving the stimulus
and… resilience funds. This seems contradictory. It will take until 2022 in
Greece and Portugal and 2023 in Spain and Italy to actually collect around 1
GDP point apiece. This corresponds to 3 billion euros for Greece, 2 billion for
Portugal, and 14 for Spain and Italy, respectively. By way of comparison,
Germany, France and the Netherlands will by then receive 5, 7 and 1 billion
euros, respectively, i.e. between 0.2 and 0.3 percent of their GDPs.

One can imagine the cries of outrage from the representatives of the frugal countries (Austria, Denmark, the Netherlands, Sweden) that these immense outgoings reward countries that are not virtuous. They should be reassured: this is no boondoggle!

[1] This text appeared in the 23 May 2020 edition
of Les Echos, without the tables.

[2] The rule for the distribution of transfers
between countries appears in the document COM (2020) 408 final/3 of 2 June
2020. For each country it depends on the size of its population, on the inverse
of GDP per capita compared to the EU-27 average, and on the difference between its
5-year unemployment rate and the EU-27 average. In order to avoid an excessive
concentration of grants to a few countries, ad hoc limits are imposed based on
these three criteria. Germany will for example receive 7% of the transfers,
France 10%, and Spain and Italy 20%, respectively.

By Magali Dauvin and Raul Sampognaro, DAP OFCE

Since the Covid-19 pandemic’s
arrival on the old continent, a number of countries have taken strict measures
to limit outbreaks of contamination. Italy, Spain, France and the United
Kingdom belatedly stood out with especially strict measures, including lockdowns
of the population not working in key sectors. Sweden, in contrast, has
distinguished itself by the absence of any lockdown. While public events have
been banned, as in the other major European countries, there were no
administrative orders to close shops or to impose legal constraints on domestic
travel[1].

Given the
multiplicity of measures and their qualitative nature, it is difficult to break
down all the decisions taken, and in particular to express their intensity.
Researchers at the University of Oxford and the Blavatnik School of Government
have nevertheless built an indicator to measure the severity of government
responses[2]. This indicator clearly shows Sweden’s specific
situation with respect to the rest of Europe (Figure 1).

The mobility data supplied
by Apple Mobility provides a complementary picture of the severity of
containment measures across countries. At the time of the toughest lockdowns, automobile
mobility was down by 89% in Spain, 87% in Italy, 85% in France and 76% in the
United Kingdom. The decline was less severe in Germany and the United States
(about 60% in both countries). Sweden ultimately saw its traffic reduced by
“only” 23%. While these data should be taken with a grain of salt,
they also give a clear signal about the timing and scale of the lockdowns in
different countries, once again pointing to a Swedish exception.

During the first half
of May, the various European countries began to gradually ease the measures
taken to combat the spread of the Covid-19 epidemic.

Sweden’s
GDP resists in Q1

In our assessment of
the impact of lockdowns on the global economy, we highlighted the correlation between the fall in
GDP observed in the first quarter and the severity of the measures put in place
to combat Covid-19. In this context, Sweden (in red in Figure 2) fares
significantly better than the OECD member countries (green bar), and especially
the rest of the European Union (purple bar). Although this is a first estimate,
GDP has not only held up better than elsewhere, but has even stabilized (‑0.1%).
Only a few emerging economies, which were not affected by the pandemic at the
beginning of the year (Chile, India, Turkey and Russia), and Ireland, which
benefited from exceptional factors, performed better in the first quarter [3].

The relative
resilience of Sweden’s GDP in the first quarter seems to suggest that the
country might have found a different trade-off between epidemiological and
economic objectives compared to other countries[4]. However, this aggregate figure masks important
developments that need to be kept in mind. In the first quarter,
the stabilisation of Swedish GDP was due to the positive contribution made by foreign
trade (up 1.7 GDP points) to a rise in exports (up 3.4% in volume terms),
particularly in January, before any health measures were taken.

In the first quarter,
Swedish domestic demand pulled activity downwards (by ‑0.8 GDP points due to household
consumption and -0.2 GDP points due to investment), as in the rest of the EU. The
shock to domestic demand was of course more moderate than in the euro area,
where consumption contributed negatively to GDP by 2.5 points and investment by
0.9 points. Nevertheless, the physical distancing guidelines issued in Sweden must
have had a significant impact during the first quarter.

In a
troubled global context, Sweden will not be able to escape a recession

If we assume that the
avoidance of a lockdown and the relatively limited administrative closures (confined
to public events) did not give rise to any significant shock to domestic demand
– which seems optimistic in view of the first quarter data – Sweden will
nevertheless be hit hard by the shock to international trade[5].

According
to our calculations, based on the entry-exit tables from the World Input-Output
Database (WIOD)^[6] and our estimates related to the
lockdown shocks in Policy Brief 69, value added is expected to fall by
8.5 points in Sweden in April due to the containment measures taken in the rest
of the world. The shock will hit its industry especially hard, more or less in
line with what we estimate globally (-19% and 21%, respectively).
Unsurprisingly, the refining industry (-32%), the manufacture of
transport equipment (-30%) and capital goods (-20%), and the other
manufacturing industries sector (-20%) will be hit hardest by the collapse
of global activity. Since a significant share of output is intended for use by
foreign industry, the worldwide containment measures will lead to a reduction
of almost 15 points in Swedish output in April (Figure 3). The same holds for commercial
services: exposure to global production chains is hurting transport and warehousing
(-15%) and the business services sector (-11%). Ultimately, the containment
measures will have an impact mainly through their effect on intra-branch trade.

The
weakness of Swedish manufacturing, weighed down by international trade, seems
to be confirmed by the first hard data available. According to the Swedish Statistical Office, exports fell by 17% year-on-year, a
figure comparable to the decline in world trade as measured by the CPB for the
same month (-16% by volume). Given this situation, manufacturing output will be
17% lower in April than a year earlier.

What
could be said about domestic demand in Q2?

In
a context of widespread uncertainty, domestic demand may continue to suffer.
Indeed, Swedish households can legitimately question the consequences of the
shock for jobs – mainly in industry – described above. On the other hand, fear
of the epidemic could deter consumers from making certain purchases involving
strong social interactions, even in the absence of legal constraints. What do
Swedish data from the beginning of Q2 tell us about Swedish domestic demand?

In
Sweden, consumer spending fell in March (-5% year-on-year). Note that the
country’s precautionary guidelines and physical distancing measures were
introduced on 10 March. The fall steepened in April, after the measures had in
force for a full month (-10% year-on-year). The measures in place hit purchases
of clothing (-37%), transport (-29%), hotels and catering (-29%) and leisure
(-11%). While the data remain patchy, May’s retail sales, an indicator that
does not cover the entire consumer sector, suggest that sales were still in a
dire state in clothing stores (-32%). In addition, new vehicle registrations
continued to fall in May (-15% month-on-month and -50% year-on-year). Pending
more recent data on activity in the rest of the economy, the volume of hours
worked[7] in May remains very low in hotels and
catering (-50%), and in household services and culture (-18%), suggesting that
significant and long-lasting losses to business can be expected.

On
the positive side, the data show a trend towards the normalization of household
purchases in May for certain consumer items. As in other European countries,
the recovery was particularly strong in household goods, where retail sales
returned to their pre-Covid level, and in sporting goods, while food
consumption remained buoyant.

Ultimately,
the health precautions taken by Sweden since the onset of containment measures are
akin to those implemented in the rest of Europe since the gradual easing of the
lockdowns. While the shocks to the consumption of certain items are less severe
than those observed in France, it is noticeable that, in the context of the
epidemic, some consumer goods could be severely affected even in the absence of
administrative closures. In addition to the recessionary impact imported from
the rest of the world, Sweden will also suffer due to domestic demand, which is
expected to remain limited particularly in certain sectors. The Swedish case
suggests that clothing, automobile, hotel and catering, and household services
and culture could suffer a lasting shock even in the absence of compulsory measures.
According to data available in May, this shock could reduce household
consumption by 8 percentage points, which represents 3 GDP points. How lasting the
shock is will depend on the way the epidemic develops in Sweden and in the rest
of the world.

[1] The Swedish institutional framework
helps to explain in part this differentiated response, which focuses more on
individual responsibility than on coercion (see https://voxeu.org/article/sweden-s-constitution-decides-its-exceptional-covid-19-policy). The country’s low population density
could also help explain the difference in behaviour vis-à-vis the rest of
Europe but not in relation to its Scandinavian neighbours.

[2] This indicator attempts to synthesize
the containment measures adopted according to two types of criteria: first, the
severity of the restriction for each measure taken (closure of schools and of businesses,
limitation of gatherings, cancellation of public events, confinement to the
home, closure of public transport, restrictions on domestic and international
travel) and second, whether a country’s measures are local or more generalized.
For a discussion of the indicator see Policy brief 69.

[3] Booming exports in March 2020 (up 39% in value) driven by strong
demand for pharmaceuticals and IT offset the fall in Ireland’s domestic demand during
the first quarter.

[4] This post on the OFCE blog does not
focus on the effectiveness of Swedish measures with regard to containing the
epidemic. Mortality from Covid-19 is higher in Sweden than in its neighbours (Norway,
Finland, Denmark), suggesting that it has run more epidemiological risks. This is
provoking a debate that goes well beyond the purpose of this post, but which does
deserve to be raised.

[5] International trade may actually impact
growth more than expected due to constraints on international tourism. In 2018,
Sweden actually ran a negative tourism deficit of 0.6% of GDP (source: OECD
Tourism Statistics Database), which could have an effect on domestic
activity if travel remains limited, especially during the summer.

[6] Timmer, M. P., Dietzenbacher, E., Los, B.,
Stehrer, R. and de Vries, G. J. (2015), “An Illustrated User Guide to the World
Input–Output Database: The Case of Global Automotive Production”, Review of International Economics., 23: 575–605

[7] In May, the volume of hours worked was
down 8% year-on-year (after -15%). The recovery in hours worked in May was due mainly
to manufacturing and construction. The recovery was less pronounced or even non-existent
in business services.