Growth and inflation in the eurozone remain much too weak. The European Central Bank’s latest assessment is bleak, and ECB President Mario Draghi has made no secret of the fact that risks remain on the downside. Nominal GDP growth – that is, real growth plus inflation – will not exceed 1.5% this year and may well end up perilously close to 1%.
Though monetary policy is supportive, it is close to reaching its limits, and the ECB’s initiative to stimulate credit by lending to commercial banks on super-cheap terms has not proved as effective as hoped. AAA ten-year government bonds currently yield about 1%, suggesting that markets do not expect a strong rebound.
This is the type of situation in which fiscal policy should come to the rescue. Draghi made that very point in his speech at the annual gathering of central bankers in Jackson Hole, Wyoming, in late August, and several economists have suggested that it is time for the eurozone to engineer a temporary fiscal expansion.
In a recent article, Francesco Giavazzi and Guido Tabellini of Bocconi University proposed a permanent tax cut, followed by gradual spending cuts. Combined with pro-growth reforms of product and labor markets, such a program could yield both lasting supply-side benefits (through lower taxation) and a temporary demand boost that would help to revive eurozone growth.