1. Fiscal Multipliers and Open Economy spillovers in a Model with Labour Turnover Costs Discussion by Raffaela Giordano Banca d’Italia – Research Department Banco de España Conference “Interactions between monetary and fiscal policies” Madrid, 25-26 February 2010

2. PLAN OF THE DISCUSSION –General comments –Brief description of the model and summary of main results –More specific comments

3. GENERAL COMMENTS (1) –Very timely: assessing the size of fiscal multipliers is crucial in current circumstances –Part of recent and large debate on the effect of fiscal stimuli on economic activity (based on both empirical VAR-based and general equilibrium models) –Main contribution: splitting the analysis among different specific measures (in particular, addressing labour demand). This is done within an open economy model that allows to account for int.l spillovers –Very relevant policy implications: the setup allows to assess not only the size of the multipliers but also the relative efficacy (e.g. CBO, February 2010)

4. GENERAL COMMENTS (2) In order to be able to do this: –Need (?) of a quite complicated framework –It is difficult to evaluate the role of each assumption in delivering the results –It is difficult to evaluate how the choice of calibration parameters (many!) affects the results –Making sure that results (both in terms of size and ranking of multipliers) are robust to different assumptions and choices of the parameters is of course crucial in this kind of analyses

5. MAIN INGREDIENTS OF THE MODEL –Open economy (two countries: currency area; RoW) –Labour market frictions (hiring and firing costs) –Infinitely living agents maximize utility by allocating wealth between consumption, domestic and int.l bonds (wealth comes from labour income, profits, financial assets); distortionary taxes on consumption, wages, profits –Monetary policy in currency area follows a rule for interest rate reacting to average inflation level in the area –Fiscal policy is conducted independently by each country –Temporary fiscal shocks financed with future lump sum taxes –Fiscal packages may include: (1) pure demand stimulus (i.e. temporary increase in gov.t expenditure), (2) consumption tax (i.e. VAT) cuts; (3) wage income tax cuts; (4) hiring subsidies (i.e. reduction in hiring costs); (5) short-term work (temporary financing part of workers’ wage)

6. MAIN RESULTS The size of the multipliers depends on: –Crowding out effect coming from expected higher future taxes –Labour market features –International spillovers coming from: effect on terms of trade and thus on export demand effect on CPI/PPI and thus on domestic wages Fiscal measures can be ranked as follows (in terms of efficacy): –Hiring subsidy –Income tax cuts –Demand stimulus –Short-time work –Consumption tax cuts

7. SPECIFIC COMMENTS (1) –Given the relevance of the results, that allows us not only to assess what is the size of the multiplier but also to rank alternative fiscal packages in terms of efficacy, one would like to evaluate to what extent the estimated size and ranking depend on particular assumptions and on calibration parameters –Look at them in turn

8. SPECIFIC COMMENTS (2): THE SIZE Assumptions: –The model accounts for several relevant real world features (open economy, frictions, wage bargaining, …)… there is one important missing feature from the picture: distortionary future taxation –Also, it is not clear the transmission mechanism through which fiscal expansions affect the interest rate and thus the real economy –Introducing distortionary taxation to finance fiscal stimuli would definitely reduce the size of the multiplier (via larger crowding out effect) –What about the other?

9. SPECIFIC COMMENTS (3): THE SIZE Calibration parameters: –The size of international spillovers crucially depends on η (elasticity of substitution between home and foreign goods) and γ (home bias in consumption) –The labour market frictions are measured by firing (f) and hiring (h) costs –Other labour mkt features (unemployment benefits, b, cost for firm under disagreement, s, workers’ bargaining power) matter –Of course, as η ↑ and γ ↓, int.l spillovers ↑ and multiplier ↓ –…as f and h ↓, multiplier ↓ –…as b and s (and workers’ b.p.) ↑, multiplier ↓ …and, what about the parametrization for foreign country?

10. SPECIFIC COMMENTS (4): THE RANKING Assumptions: –Lump sum taxation …maybe irrelevant for ranking Calibration parameters: –As labour market frictions ↓, relative effectiveness of “supply side” stimuli should decrease (also as workers’ bargaining power ↓, …) –What about the parameters affecting the international spillovers? …maybe irrelevant for ranking A robustness check to alternative calibrations would be instructive!

11. MINOR COMMENTS –Monetary policy is not really suitable to address crises: (i) the parameter b п =1.5 is not calibrated on crises; (ii) policy rate is not allowed to be constrained by zero lower bound (Christiano et al. 2009; Woodford, 2010) → size of multiplier may be underestimated –Monetary policy reacting to average inflation level in the area; how does this “rationalize the behaviour of the stability pact”? –Weird arbitrage condition between nat.l and int.l interest rates → intermediation costs when investing in international portfolio. Why? How does this affect the results? –Government expenditure just enters in the resource constraints (with a minus sign) → pure waste (?) → fiscal stimulus should be described as a reduction in g Check for description of fiscal packages adopted in euro area countries! For Italy, look at http://www.bancaditalia.it/pubblicazioni/econo/bollec/2009/bolleco58/en_bollec54

12. SUMMING UP –Assessing the effectiveness of fiscal measures as a means of increasing output and employment is crucial, above all in times of crisis –The size of fiscal multipliers typically depends on the presence (and magnitude) of delays in adjustment of prices or wages and more generally of frictions, and on monetary policy reaction –My impression is that in this paper the effectiveness of fiscal policy tends to be over-estimated in normal times … maybe under-estimated during crises –Regardless quantitative assessments, the paper has the merit to explicitly consider labour market measures and, more generally, to highlight the usefulness of concentrating efforts where distortions are highest