THE RECESSIVE ATTITUDE OF EMU POLICIES: REFLECTIONS ON THE ITALIAN EXPERIENCE WITHIN THE LAST TEN YEARS

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THE RECESSIVE ATTITUDE OF EMU POLICIES
REFLECTIONS ON THE ITALIAN EXPERIENCE WITHIN THE
LAST TEN YEARS

• by Rosaria Rita Canale and Oreste Napolitano
• Universitià di Napoli Parthenope Dipartimento
  di Studi Economici Salvatore Vinci

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• Aim of the paper
• To show, through the measurement of the effect of
  public expenditure and interest rate setting on
  national income in Italy from 1998 to 2008 that,
• A) government expenditure had a central role in
  determining the growth rate of GDP
• B) before the crisis monetary policies had real
  effects, while during financial crisis it was
  unable to inject money in the market
• To underline the weakness and the recessive
  attitudes of European policy framework both on
  the side of fiscal and monetary policy

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• European economic policy framework Theoretical
  foundations I
• Monetary policy (NCM)
• Stream of thought I
• time inconsistency (Kydland e Prescott 1977)
• only unanticipated money matters (Lucas 1972,
  Sargent and Wallace 1975)
• destabilizing effects on expectations
• Stream of thought II (NKM)
• The efficacy depends on
• labour, credit or goods market imperfections
  (Blanchard 2008)
• Unanticipated price changes (Posen 2008)

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• European economic policy framework Theoretical
  foundations II
• Fiscal policy
• Public expenditure creates expectations of grater
  future taxation and public debt (Barro 1974)
• Crowding-out effect
• Inflationary effect
• Politicians subordinate decisions to consensus
  mechanism (Buchanan and Tullok 1962, Solow 2005)

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• EMU Macroeconomics fundamentals
• Short period policies are not desirable because
  of their effects on inflation
• Inflation is a monetary phenomenon
• GDP and unemployment fluctuate around their long
  run equilibrium level. This last one does not
  depend on active fiscal and monetary policies
• These principles represent the theoretical
  underpinnings of Maastricht Treaty and Stability
  and Growth pact, whose main objective is the
  avoidance of any monetary disturbance for the
  convergence toward the natural unemployment rate
  (Arestis and Sawyer 2003 and Arestis, McCauley
  and Sawyer 2001)

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• Theoretical limits of macroeconomic consensus
• The reference interest rate is fixed by the
  Central Bank (Canale et alii 2009)
• Money is not neutral especially in condition of
  unemployment
• A behavioural equation rather than an identity
  describes the process of GDP formation (see
  Krugman 2009 vs Cochrane 2009 and Fama 2009)
• Wealth effect on public debt

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• Empirical evidence does not give unequivocal
  results
• Monetary policy
• Effects on income and prices in imperfect
  markets. Cochrane (1998) Clarida, Gali and
  Gertler (1999 and 2000) and Galì and Gertler
  (2007)
• The CB cannot fix negative interest rates so that
  it is not always possible to make output to
  converge just taking after inflation. Benhabib,
  Schmitt-Grohé e Uribe (1999)
• Fiscal Policy
• Problems of variables identifications (Perotti
  2007) Blanchard and Perotti (2002)
• The multiplyer is positive. Mihov (2001)
  Monacelli and Gali (2005) Fatas and Mihov (2009)
  Alesina, Campante and Tabellini (2007)
• Ricardian equivalence is not univocally
  demonstrated Hemming, Kell e Mahfouz, (2002)
• The policy efficacy depends on the joint action
  of monetary and fiscal policy
• See Canale (2009) and Canale et al (2008) vs
  Giavazzi and Pagano (1990) etc
• Consolidated empirical literature uses VAR
  technique to evaluates the response to shocks of
  e.g. aggregate equilibrium income, and therefore
  assumes that an equilibrium value already exists
• We use OLS technique to capture the measure of
  contribution to income of the independent
  variables

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Macroeconomic performance of fiscal and monetary
policy in Italy from 1992 to 1998

• Economic policies with the aim of joining the EMU
• Interest and inflation rates convergence
• Public deficit reduction strategy
• No great effects on GDP growth (0,6)

9

• Macroeconomic performance of fiscal and monetary
  policy in Italy 1999-2008

The 1999-2001 period growth and improvements of
public accounts the 2001-2008 period a slow down
of growth and progressive deterioration of public
accounts
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Empirical analysis I the model

• We use a model according to which equilibrium
  income is determined by its components not
  simultaneously.
• Therefore it assumes the following form
• (1)
• Where (t-i) is the index of lagged variables
  influencing GDP
• The equation (1) can be re-written as
• (2)
• In order to examine the influence on income of
  fiscal and monetary policy and avoid problems of
  autocorrelations we estimate one variable at a
  time

or .
or
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• Empirical analysis I results
• The first estimate represents the effects of
  public expenditure (Tex) on GDP (Table 2) .
• Empirics shows that public expenditure had a
  positive correlation with nominal GDP from 1998
  to 2008
• Table 2. Public expenditure effects on nominal
  GDP
• Dependent Variable GDP1 (nominal index of GDP)

Variable Coefficient t-statistic
C 76.18828 7.038606
Tex(-1) 0.491754 5.899669
R2 0.484723 Obs. 39, Sample (adjusted) 199902 20084 D-W stat 1.400407 AIC 7.566932 F-stat 34.80610 R2 0.484723 Obs. 39, Sample (adjusted) 199902 20084 D-W stat 1.400407 AIC 7.566932 F-stat 34.80610 R2 0.484723 Obs. 39, Sample (adjusted) 199902 20084 D-W stat 1.400407 AIC 7.566932 F-stat 34.80610
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• Empirical analysis I results
• The second estimate shows the effects of public
  expenditure (Tex) on real GDP (table 3).
• Empirics shows that from 1998 to 2008 public
  expenditure had a positive correlation with real
  GDP
• Table 3. Public expenditure effects on real GDP
• Dependent Variable GDP2 (real index of GDP)

Variable Coefficient t-statistic
C 106.0451 28.53820
Tex(-1) 0.163956 5.729890
R2 0.470514 Obs. 39, Sample (adjusted) 199902 20084 D-W stat 1.3988210 AIC 5.428578 F stat 32.83164 R2 0.470514 Obs. 39, Sample (adjusted) 199902 20084 D-W stat 1.3988210 AIC 5.428578 F stat 32.83164 R2 0.470514 Obs. 39, Sample (adjusted) 199902 20084 D-W stat 1.3988210 AIC 5.428578 F stat 32.83164
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• Empirical analysis I results
• Results do not have a great change if we consider
  jointly the effects of total expenses (Tex) and
  total revenues (rev) on GDP
• Tables 4 describes the regression results both on
  nominal GDP index
• Table 4. Joint effects of public expenditure ant
  revenues on nominal GDP
• Dependent Variable GDP1 (nominal index of GDP)

Variable Coefficient t-statistic
C 71.36942 6.310181
Tex(-1) 0.321952 3.514355
Rev(-3) 0.198156 2.704307
R2 00.530097.797115 Adjusted R2 0.502455 Obs. 37 Sample (adjusted) 199904 20084 D-W stat 1.969720 AIC 7.400598 F stat 19.17764 R2 00.530097.797115 Adjusted R2 0.502455 Obs. 37 Sample (adjusted) 199904 20084 D-W stat 1.969720 AIC 7.400598 F stat 19.17764 R2 00.530097.797115 Adjusted R2 0.502455 Obs. 37 Sample (adjusted) 199904 20084 D-W stat 1.969720 AIC 7.400598 F stat 19.17764
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• Empirical analysis I results
• Tables 5 describes the regression results taking
  into account the real GDP index
• Table 5. Joint effects of expenditure and
  revenues on real GDP Dependent Variable GDP2
  (real index of GDP)

Variable Coefficient t-statistic
C 105.6890 27.75564
Tex(-1) 0.104996 3.404221
Rev(-3) 0.059835 2.425457
R2 0.498782 Adjusted R2 0.469298 Obs. 36 Sample (adjusted) 200001 20084 D-W stat 1.835883 AIC 5.223311 F stat 616.91736 R2 0.498782 Adjusted R2 0.469298 Obs. 36 Sample (adjusted) 200001 20084 D-W stat 1.835883 AIC 5.223311 F stat 616.91736 R2 0.498782 Adjusted R2 0.469298 Obs. 36 Sample (adjusted) 200001 20084 D-W stat 1.835883 AIC 5.223311 F stat 616.91736
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Empirical analysis I results

• Table 6 describes the real effects of repurchase
  rate setting. As we can see the coefficient is
  negative and significant.
• Table 6. Real effect of monetary policy strategy
  I
• Dependent Variable GDP2 (real index of GDP)

Variable Coefficient t-statistic
C 10.62128 3.430827
GDP2(-1) 0.924243 38.34049
Rep_rate(-2) -0.317137 -2.338799
R2 0.977134 Adjusted R2 0.975827 Obs. 38 Sample (adjusted) 199903 20084 D-W stat 1.936779 AIC 2.234471 F stat 747.8319 R2 0.977134 Adjusted R2 0.975827 Obs. 38 Sample (adjusted) 199903 20084 D-W stat 1.936779 AIC 2.234471 F stat 747.8319 R2 0.977134 Adjusted R2 0.975827 Obs. 38 Sample (adjusted) 199903 20084 D-W stat 1.936779 AIC 2.234471 F stat 747.8319
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Empirical analysis I results

• Results do not change if we consider the EONIA
  rate instead of repurchase rate, because of the
  direct proportionality between the two rates
• Table 7. Real effect of monetary policy strategy
  IIDependent Variable GDP2 (real index of GDP)

Variable Coefficient t-statistic
C 10.89945 3.492447
GDP2(-1) 0.924399 38.31560
Eonia(-2) -0.303109 -2.321781
R2 0.977089 Adjusted R2 0.975780 Obs. 38 Sample (adjusted) 199903 20084 D-W stat 1.957125 AIC 2.236432 F stat 746.3319 R2 0.977089 Adjusted R2 0.975780 Obs. 38 Sample (adjusted) 199903 20084 D-W stat 1.957125 AIC 2.236432 F stat 746.3319 R2 0.977089 Adjusted R2 0.975780 Obs. 38 Sample (adjusted) 199903 20084 D-W stat 1.957125 AIC 2.236432 F stat 746.3319
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Interesting results come out of the empirical
analysis of the relation between debt and GDP.
Coefficient is positive and significantTable 8.
Real effects of public debtDependent Variable
GDP2 (real index of GDP)
Empirical analysis I results
Variable Coefficient t-statistic
C 19.96988 7.230646
GDP2(-1) 0.772619 17.88903
Debt(-1) 0.078703 2.755561
R2 0.9839600 Adjusted R20.983158 Obs. 43 Sample (adjusted) 199802 20084 D-W stat 1.634168 AIC 2.482092 F stat 1226.903 R2 0.9839600 Adjusted R20.983158 Obs. 43 Sample (adjusted) 199802 20084 D-W stat 1.634168 AIC 2.482092 F stat 1226.903 R2 0.9839600 Adjusted R20.983158 Obs. 43 Sample (adjusted) 199802 20084 D-W stat 1.634168 AIC 2.482092 F stat 1226.903
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• Comments on results
• The positive relation between government
  expenditure and GDP shows that in the years from
  1998 to 2008 fiscal policy in Italy influenced
  growth both in nominal and real terms (Tables 2,
  3, 4, 5)
• The negative relation between the repurchase rate
  (or EONIA) and real income brings us to conclude
  that, because of the direct proportionality with
  all other rates in the market, monetary policy
  had in the years considered a negative effect on
  GDP (Tables 6 and 7)
• Despite mainstream literature assertions about
  the Ricardian equivalence and the negative
  effects of public debt, empirical evidence shows
  that public debt had same sign effects on real
  GDP (table 8).

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• Empirical Analysis II The Kalman filter
• We use the Kalman filter methodology to evaluate
  how the coefficients of the main variables
  influencing GDP have been varying through time.
• Assuming that ßi,t was determined by an
  autoregressive process AR(n), we use the
  following model with changing parameters
• Where yt is the GDP, µit is a identified by a
  white noise process, and the vector of
  coefficients ßi,t is random walk.

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• Empirical Analysis II The Kalman filter results
• Results are presented in table 9 and in figures 5
  and 6.
• Coefficients have a sign consistent with the OLS
  regression and are significant. The path of
  coefficient ßi,t (figures 5 and 6) appear to add
  interesting results about dynamic effects of
  monetary and fiscal policies in that period.
• Table 9. The Kalman estimations

(rep_rate) b1,t b2,t
AIC7.03 Schwarz7.07 Obs. 38(Q) 127.03 (76.59) 0.000 -0.2865 (-11.29) 0.003
(Govern. Expenditure)
AIC8.61 Schwarz8.65 Obs. 39 (Q) 73.81 (6.687 ) 0.000 0.50111 (6.054) 0.000
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• The Kalman filter and monetary policy
• It is interesting to note that the coefficient of
  the discount rate changed few years after the
  EURO (figure 5)
• The second relevant change in the discount rate
  coefficient occurs around the year 2006. Figure
  5 shows that in that period there is an inversion
  of the path. The opposite effect of interest
  rates movements on GDP reduces and, at a time of
  financial crises, it approximates to zero.
• Around the year 2008 happened a kind of liquidity
  trap, testifying the fact that the interest rate
  lowering policy was not able to inject money in
  the market during the crisis

Figure 5. Monetary policy coefficient behaviour
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• The Kalman filter and fiscal policy
• On contrary public expenditure coefficient is
  always positive testifying the fact that
  government expenditure had a great part in
  determining the GDP in those years.
• The coefficient of the public expenditure is
  positive and ever increasing till the end of the
  period

Figure 6. Fiscal policy coefficient behaviour
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• Conclusions
• In Italy in the period from 1998 to 2008
• Public expenditure had same sign effects on GDP
• Debt did not have negative effects
• Monetary policy had real effects
• The effects of fiscal policy have been growing
  through time
• Monetary policy reduced its influence on GDP
  during the crisis
• Generalizing the Italian results
• Because of the lack of a shared fiscal policy and
  of an inflation targeting monetary policy
  strategy, the economic policy structure in EMU
• Is unable to contrast current economic crisis
• Hardly weakens the existence of the monetary
  union as a whole (Krugman, 2009, Wray 2003)