From Grexit to Exitaly? Let’s Stop This Madness

If Berlin, Frankfurt and Bruxelles continue to say “no”, there won’t be alternatives to Grexit, and that’s the end of the euro as we know it. At that point the euro architecture will have failed (in fact, it has already failed) and the very idea of Europe of Europe’s founding fathers will have died (in fact, it has already died).

If Greece does exit the euro, nobody knows what will happen next. A country like Italy is seriously exposed, and the simple thought that it might be the next to tremble should be enough to scare the hell out of us all, including the euro orthodox thinkers who have brought us to this point.

But even if nothing serious happens, and Grexit is absorbed costlessly (safe for the Greeks, but “who cares about the Greeks?” Europe VIPs would wonder…), there is no way for a country like Italy to raise itself from its debt-cum-depression trap without a major boost to internal demand.

A country like Italy for too many years has been bound to navigate without steering wheel. It has no macro-policy instruments left: no monetary policy, no exchange rate policy, and no fiscal space available (with the exception of a few decimal points allowed within the fiscal compact); “its” central bank (the ECB) has been pursuing a de facto asymmetric objective: overreacting to any symptom of inflation beyond 2 percent, accepting passively zero inflation until when – very much belatedly – Mr. Draghi was able change course. If cancelling Greek debt is taboo, let’s imagine how simply impossible would that be for Italy… Yes, there are important reforms that Italy should undertake, including strengthening the administration of civic justice, fighting pervasive corruption, modernizing education, changing the selection process of the ruling class, just to cite a few. But even assuming that this is done, what are the chances that this triggers demand and jumpstart growth any time soon? Zero.

In short, even if negative growth has bottomed out in Italy, there is nothing that can prevent Italy from remaining trapped indeterminately in a situation of stagnation with increasing debt.

What should be done? We reiterate our proposal. Italy needs a huge reduction of its fiscal burden. How?

The government issues rights to tax cuts two years after issuance. Call these rights tax credit certificates (TCCs). These are non-debt bonds only commit the government to reduce the tax burden of their bearers by an amount equivalent to the nominal value of the bonds two years after the bonds have been issues. We’ll see why the two-year deferral in a moment.

The TCCs are transferable, can be sold in exchange for euros, and may be thus used to finance immediate spending. Those who sell TCCs want to get euros to buy stuff. Those who buy TCCs want to acquire rights to future tax cuts (which means more future savings). Financial intermediaries can buy TCCs from sellers at a discount and either use them for future tax cuts or resell them at a lower discount and earn a profit.

The government allocates newly issued TCCs to households and enterprises. Many households will want to convert them to finance consumption. Enterprises can use the tax reductions to cut their prices and gain competitiveness. In a depressed economy, the new spending triggered by TCC issuances will have multiplier effects on output and employment. Credit prospects will improve and banks will have an incentive to start lending again to finance production and investment. The new output will raise fiscal revenues. As projections show, a small multiplier (0,8) and the two-year deferral on the TCC would be enough to avoid that the fiscal deficit in two years time would increase as a result of the TCC-induced fiscal cut.

In previous articles we have indicated that the TCCs could act as a quasi-money instrument and a currency parallel to the euro, and that they could even be used by the public as a substitute for the euro to facilitate payments. This has raised a lot of misunderstanding, in particular through the argument that the new instrument would break the rules of the euro.

This is non-sense, since the TCCs would not be issued by the government as a new currency and would not have the purpose of replacing the euro, even though the public and the market might use them any way they wish (as for any bond or asset). The only relevant fact is that the TCCs would make possible for the government to engineer a huge tax cut in a situation where no other policy lever is available. The TCCs allow for an intertemporal fiscal transfer from the future to the present, enabling immediate spending and allowing the time and the outpu response to generate the resources to finance the intertemporal transfer.

Are there risks that this might not work?

No: if basic Keynesian macroeconomics is right, and from 2008 onwards evidence has massively piled up indicating that it is.

No: if expansionary austerity proves to be a deep failure, as it has.

Besides, TCC issuances can be engineered in a way that includes “safeguard clauses” if the increase in output generates less fiscal revenues than anticipated. In our previous post on EconoMonitor (, we have offered some examples:

  • First, the government could announce a commitment to pay a fraction (presumably, just a small one) of its public expenditures with TCCs.
  • Second, taxpayers could be entitled to receive TCCs as compensation for additional euro tax payments: this would be equivalent to replacing tax raises with compulsory TCC-for-euro swaps.
  • Third, TCC holders could be incentivized to postpone the use of TCCs for tax reductions by receiving an increase in their face value (equivalent to interest income being paid in the form of TCCs).
  • Fourth, the government could raise euros in the market by placing TCCs with longer maturities instead of debt bonds.

In any case, these safeguards would be much less pro-cyclical than those imposed by the EU to secure budget targets through spending cuts or tax hikes. In fact, one or more of them used in combination would easily accommodate for even significant shortfalls in primary budget surplus targets.

Mr. Renzi, please let’s stop this madness and let’s Italy out of this trap.