The classic story told to illustrate the problem of establishing fiscal credibility is the one of Odysseus and the Sirens in Homer’s Iliad. This analogy was minted by a previous generation operating with the sexual politics of its age.
The Sirens were mythological creatures, half bird, half woman, who tempted sailors away from their naval duties with song and then killed them, instigating an enduring misogynist cultural tradition of demonising female sexuality. Circe warns Odysseus before a voyage during which he would journey within earshot:
“They sit in a green field and warble him to death with the sweetness of their song. There is a great heap of dead men’s bones lying all around, with the flesh still rotting off them.”
Odysseus faced what economists call a time-consistency problem: a conflict between his current and future selves. Today, Odysseus fancies hearing the Sirens’ song to find out what all the fuss is about, and feels in control. But he worries about tomorrow’s Odysseus. Tomorrow, Odysseus will lose control when he is bewitched by the voices and make for the Sirens, leading to his death and the deaths of those in his charge. The solution is described plainly in the text:
“Therefore pass these Sirens by, and stop your men’s ears with wax that none of them may hear; but if you like you can listen yourself, for you may get the men to bind you as you stand upright on a cross-piece half way up the mast, and they must lash the rope’s ends to the mast itself, that you may have the pleasure of listening. If you beg and pray the men to unloose you, then they must bind you faster.”
Politics and policymaking is replete with captains tying themselves to masts: Keir Starmer listing ‘pledges’ in the Labour leadership election; David Cameron’s immigation targets; the “Ed-stone”; Gordon Brown legislating for Bank of England independence in 1997; and of course, many examples of rules for fiscal policy, the corpses of which are littered in the careers of finance ministers.
Today’s fiscal mariner wants to respond flexibly to the economy, injecting stimulus here, withdrawing it there, as the economy dictates, mindful of long term fiscal sustainability and of not scaring financial markets so that the cost of finance stays low. Tomorrow’s fiscal self faces re-election, and, like the future Odysseus fixated on the Sirens’ voices, cares about nothing else. Knowing this, today’s fiscal self ties to the mast of a verbal commitment some kind of rule that promises not to splurge in an election campaign. As you are probably suspecting, this is not as successful a commitment as binding your hands and feet to the mast of a ship.
The emergence of the Covid-19 pandemic has blown the infrastructure of fiscal and monetary rules out of the proverbial water. This particular piece started life a month ago as a column reflecting on how the Chancellor would weigh up the need to respect austerian fiscal statements in the December 2019 general election manifesto against the temptation to please new Northern constituents, recently turned from Labour to Tory, who might have voted for Johnson’s Brexit policy, but would want other things to be more, well, Labour.
But the unprecedented scale of the crisis unfolding made the old delicate balancing calculation – and early drafts of this article – irrelevant.
The public health strategy to fight Covid-19 is to shut down a large part of the economy to reduce the need for people to come into contact with each other, and thereby slow and halt the spread of the virus, limiting intensive care admissions and deaths. Both for ethical reasons – to compensate people for the income loss they will suffer – and to encourage them to consent with social distancing and not feel sufficiently desperate that they have to try to evade it to earn money, the government has committed to huge financial support directed at firms, employees, and now the self-employed.
It is hard to know how much these commitments might ultimately cost, because we can’t know for sure for how long the economy will need to remain shut down, and to what degree. But it is not hard to imagine that they might total 50 per cent of GDP spread over a couple of years.
Covid-19 is having the same effect on the continent. The “Stability and Growth Pact”, which set out fiscal rules for Eurozone members, constraining deficits and debt (often honoured in the breach), has been set aside by the European Commission. And Germany, typically resolute in attempting to balance its government budget, has subsequently embarked on a hefty stimulus package comprising spending of €350bn and loan guarantees of a further €4000bn.
The virus is also resurrecting discussions about whether the Eurozone might create a Eurozone-wide Government bond. This would mean, for example, German taxpayers being potentially on the hook to pay off debt issued by the Italian or Greek governments. This makes it possible for those governments, whose fiscal space to finance their own Covid-19 strategies is more limited, to do more without causing financial markets to panic about their ability to pay that debt back.
The absence of a Eurobond at the instigation of the Euro was a fiscal rule of sorts: one that prevented individual member state governments issuing debt that entailed any obligation by other member states to make good. It was a rule insisted on by those countries who thought of themselves as fiscally well behaved to protect them from those that had not been. And just like the ultimately irresistible song of the Sirens, it has proved hard to hold the line. The bail-outs of Ireland, Portugal and Greece all involved other member states accepting some kind of obligation for others’ fiscal predicament. Now there are more explicit discussions of a Eurobond.
It is hard to map between the story of the Sirens and the Eurobond at this point. In the original story, untying himself from the mast would doom Odysseus to death. In reality, not relenting and creating the Eurobond could be what dooms the Eurozone to death. One of the pivotal moments of the Eurozone financial crisis was the attempt by Greece’s then-PM Alexis Tsipras and his finance minister Yanis Varoufakis to force more generous bail-out terms by insinuating that a disorderly Greek exit from the Euro would cause markets to run from other governments’ bonds and banks. This did not happen. Greece’s bluff was called successfully. It is far less clear that the Eurozone could withstand a disorderly exit by Italy, which being so much larger, poses a much greater threat to other member state governments and banks if it were to default.
And the risk is not just financial doom too. Without the fiscal capacity to withstand and incentivise the lockdown, the lockdown may not endure or be endurable, and without that the poorer countries will have less success taming the virus, and constitute a more dangerous reservoir of the virus on the richer countries’ borders.
Whether the Eurozone collectively figures this out remains to be seen. This magazine carried a piece documenting a call by seven leading German economists for a Eurobond. So far 14 Eurozone countries have come out in support: Belgium, France, Italy, Luxembourg, Spain, Portugal, Greece, Slovenia, Ireland, Cyprus, Lithuania, Latvia, Estonia, Slovakia. Northern European countries Germany, Austria and the Netherlands are against (interestingly the Dutch central bank governor felt motivated to go on record as describing the initiative as “understandable”). Part of the reason for the impasse is the difficulty of coming up with a mast to tie to that demarcates measures to combat Covid-19 from spending generally or places control over future spending and taxes in collective hands.
The effect of the virus on fiscal rules may be more far-reaching still. It is potentially undermining a more energetically defended fiscal taboo: the one that insists you do not pay for government programmes by printing money.
This prohibition of monetary financing is enshrined in the German constitution, one forced on that country by Allied powers determined that there would not be a repeat of the pre-war German hyperinflation, which was judged to have been one of the proximate causes of the dynamic that encouraged the rise of the Nazis. This feature of the German constitution is inherited by the Lisbon Treaty: a necessary part of the agreement that although Germany would deprive itself of its monetary autonomy, it could and would not do so in a way that required a constitutional amendment.
More recent examples of the effects of rampant monetary financing – such as the hyperinflationary economic collapses in Zimbabwe and Venezuela – serve to illustrate why the firewalls against it were there. Money printing does not make all that much money at rates of inflation that do not destroy the economy. Moderate inflation rates experienced by Western economies generated profits from money printing at a fraction of a per cent of GDP.
Signs that the firewalls are not as impermeable now are not hard to find. The ECB currently lends to banks at a lower rate than banks deposit with it, and the small profits Eurozone banks can make from this is financed by creating electronic money. The ECB recently removed the limits on the proportion of a member state’s bonds that might be bought as it steps up new quantitative easing purchases. Those limits were there partly to ensure that the ECB could not buy bonds for which there weren’t also willing private sector investors. Without evident private sector demand for those bonds, there looms the possibility that they can’t be paid back and the money created to buy them by the ECB will never be unwound. The Fed, ECB and the Bank of England have all announced large new purchases of their respective sovereign’s bonds. Concerted efforts were made after the last crisis to differentiate QE from monetary financing by promising that it would be reversed. The fact that much of it wasn’t before this latest round of purchases began is going to plant the thought that these latest operations will turn out to be indistinguishable from monetary financing when history looks back on them.
When the crisis is over, there will have to be a financial reckoning. The resources consumed while lockdown deprives many of their income have to come from somewhere. Even a relatively dire scenario where afflicted economies lose a year’s worth of GDP should in principle be born easily. The current cost of financing government debt is about zero. This provides time for organising a paydown of the debt incurred that spreads the burden of today’s counter-measures over future generations. A year’s worth of GDP spread over 50 years means just a 50th less disposable income subsequently, each year, and, optimistically, much less than that, presuming economic growth resumes at something approaching pre-Covid-19 rates.
Future generations of course have their own pandemic risk with which to contend, and the consequences of our neglect of climate change. They are by definition not around to demand a seat at the table for how the reckoning for the costs of fighting Covid-19 is designed. This will be the backdrop for new discussions about fiscal rules and frameworks that will inevitably restart at some point.