1. and Inequality Macroeconomics and Inequality Francesco Saraceno The Euro after the crisis: lessons from the past and challenges for the future Cambridge December 15, 2010

2. Outline The Trend towards Increasing Inequality The Trend towards Increasing Inequality  A worldwide phenomenon  The role of policy The Macroeconomic Effects of Increased Inequality The Macroeconomic Effects of Increased Inequality Macroeconomic Performance in the EU and in the US Macroeconomic Performance in the EU and in the US Eurosclerosis? Eurosclerosis?  Arguments in favour of structural reforms  Public Sector Performance  A European Paradox

3. Outline The Trend towards Increasing Inequality The Trend towards Increasing Inequality  A worldwide phenomenon  The role of policy The Macroeconomic Effects of Increased Inequality The Macroeconomic Effects of Increased Inequality Macroeconomic Performance in the EU and in the US Macroeconomic Performance in the EU and in the US Eurosclerosis? Eurosclerosis?  Arguments in favour of structural reforms  Public Sector Performance  A European Paradox

4. The Trend towards Increasing Inequality Common trend (and overall undisputed) Common trend (and overall undisputed) “ Superstar Economy ” (Gordon and Dew Becker) “ Superstar Economy ” (Gordon and Dew Becker)

5. The Trend towards Increasing Inequality II The Gini index is subject to many criticisms, so we can just focus on the trend The Gini index is subject to many criticisms, so we can just focus on the trend

6. The Causes of Inequality: The Role of Policy Progressivity of the tax system has strongly decreased Progressivity of the tax system has strongly decreased

7. The Causes of Inequality: The Role of Policy II

8. The Causes of Inequality: The Role of Policy III Shift of taxation from high to low incomes, and from capital to labour. Shift of taxation from high to low incomes, and from capital to labour. Result: Generalized decrease of the wage share Result: Generalized decrease of the wage share

9. Outline The Trend towards Increasing Inequality The Trend towards Increasing Inequality  A worldwide phenomenon  The role of policy The Macroeconomic Effects of Increased Inequality The Macroeconomic Effects of Increased Inequality Macroeconomic Performance in the EU and in the US Macroeconomic Performance in the EU and in the US Eurosclerosis? Eurosclerosis?  Arguments in favour of structural reforms  Public Sector Performance  A European Paradox

10. Macroeconomic Effects of Increased Inequality The poor have a higher propensity to consume The poor have a higher propensity to consume  Liquidity constraints  Subsistence consumption  Satiation  Etc. Transfer of wealth to the rich reduces propensity to consume as well as the consumption structure Transfer of wealth to the rich reduces propensity to consume as well as the consumption structure Unless we live in a world in which S = I ex ante, this may lead to the consequence that demand and growth stagnate Unless we live in a world in which S = I ex ante, this may lead to the consequence that demand and growth stagnate Question: if the increase of inequality is widespread, and if it tends to depress growth, why do growth performances differ, notably across the ocean? Question: if the increase of inequality is widespread, and if it tends to depress growth, why do growth performances differ, notably across the ocean?

11. Outline The Trend towards Increasing Inequality The Trend towards Increasing Inequality  A worldwide phenomenon  The role of policy The Macroeconomic Effects of Increased Inequality The Macroeconomic Effects of Increased Inequality Macroeconomic Performance in the EU and in the US Macroeconomic Performance in the EU and in the US Eurosclerosis? Eurosclerosis?  Arguments in favour of structural reforms  Public Sector Performance  A European Paradox

12. "My Crisis, your Problem" Change between 2010q2 & 2008q1 FRADEUITAJPNUSAGBRSPAIN GDP per capita (%)-3.5-2.3-7.1-4.5-3.2-5.8-6.0 GDP (%)-2.2-2.7-5.6-4.3-1.1-4.5-4.6 Unemployment (points) +2.1-0.6+2.2+1.4+4.9+2.6+10.8 In spite of the sluggish recovery the US did comparatively well in terms of GDP In spite of the sluggish recovery the US did comparatively well in terms of GDP Caveat: Most of the effects of the recession are felt on employment Caveat: Most of the effects of the recession are felt on employment

13. Global Recovery Will Remain Moderate OECD area, unless otherwise stated

14. Nothing New Under the Sky

15. Why the EMU did Worse than the US? At the early stages of the crisis it was expected that Europe would be less hit than the US At the early stages of the crisis it was expected that Europe would be less hit than the US  Excessive activism of macroeconomic policies (in particular monetary policy) of the Unites States  Excessive deregulation of financial markets Europe’s growth model Europe’s growth model  Strong regulation  Prudent macroeconomic policies What went wrong? What went wrong?

16. Outline The Trend towards Increasing Inequality The Trend towards Increasing Inequality  A worldwide phenomenon  The role of policy The Macroeconomic Effects of Increased Inequality The Macroeconomic Effects of Increased Inequality Macroeconomic Performance in the EU and in the US Macroeconomic Performance in the EU and in the US Eurosclerosis? Eurosclerosis?  Arguments in favour of structural reforms  Public Sector Performance  A European Paradox

17. Why are the US growing more than Europe? Why are the US growing more than Europe? Common Wisdom: In two words: Washington Consensus Common Wisdom: In two words: Washington Consensus  More flexible economy  Less regulation, less rigidities.  Less distortions in the incentive mechanism  This explains the difference e.g. in the impact of the ICT revolution Implication: Europe has to go for structural reforms Implication: Europe has to go for structural reforms This is the philosophy behind the European institutions This is the philosophy behind the European institutions  Stability Pact  ECB Statute Lessons for Europe

18. Problems with Structural Reforms The importance of structural reforms is beyond doubt, but it may be overstated The importance of structural reforms is beyond doubt, but it may be overstated A number of reforms have already been implemented. A number of reforms have already been implemented.  Goods market: Privatization, deregulation  Labour market: Multiplication of contract types, temporary jobs, reform of unemployment benefit systems, wage moderation

19. Problems with Structural Reforms II EPL index*. Selected years 1985199520052008 Denmark2.41.51.51.5 Finland2.332.162.021.96 France2.792.983.053.05 Germany3.173.092.122.12 Greece3.563.52.732.73 Italy3.573.571.821.89 Spain3.823.012.982.98 Sweden3.492.472.241.87 UK0.60.60.750.75 US0.210.210.210.21 EMU11** -2.752.232.2 Source: Creel and Saraceno (2010) While we have dual system, with protected insiders and outsiders, the marginal worker is not a source of rigidity While we have dual system, with protected insiders and outsiders, the marginal worker is not a source of rigidity

20. So, if it is not (only) market flexibility, what else can it be? So, if it is not (only) market flexibility, what else can it be? Difference often neglected: Policies are also very different Difference often neglected: Policies are also very different  Active in the US  Very inertial in Europe This corresponds to two different theoretical backgrounds This corresponds to two different theoretical backgrounds Shocks plus Institutions, Once More

21. Macroeconomic policy has been proactive in the US, and very inertial in the EMU Macroeconomic policy has been proactive in the US, and very inertial in the EMU Policy Divergence or Market Flexibility? Fiscal Policy Monetary Policy

22. US, UK, Spain, increasing indebtedness US, UK, Spain, increasing indebtedness Consumption out of income substituted by consumption out of debt Consumption out of income substituted by consumption out of debt Institutions, not Only Policy

23. Institutions, not Only Policy II

24. Conclusion: A European Paradox The US institutional setup is consistent: The US institutional setup is consistent:  Extreme market flexibility and weak collective insurance  Fluctuations are smoothed by proactive macroeconomic policies The EMU on paper is also consistent The EMU on paper is also consistent  Strong welfare state and automatic stabilization  Constraints to discretionary macroeconomic policies What about the EMU in reality? What about the EMU in reality?  Huston, we have a problem…

25. One First (impossible) best, political integration … One First (impossible) best, political integration … … four feasible reforms … four feasible reforms  A “ solidarity stabilization fund ”  Golden Rule of Public Finance (to allow financing public investment by borrowing)  “ Political ” determination of the inflation objective (Bank of England?)  More pragmatic approach to competition policy, in order to allow the conduct of a true industrial policy … … and a question mark: … and a question mark:  Exchange rate policy? The Future?

26. Where does this come from? Fitoussi, J. P. and F. Saraceno (2010), "Europe: How Deep Is a Crisis? Policy Responses and Structural Factors Behind Diverging Performances", Journal of Globalization and Development, 1(1), Article 17. Fitoussi, J. P. and F. Saraceno (2010), " Inequality and Macroeconomic Performance “ Document de Travail de l ’ OFCE, 2010-13 Creel, J. and F. Saraceno (2010). "Automatic Stabilisation, Discretionary Policy and the Stability Pact", paper presented at the Bank of Italy Conference on Fiscal Policy and the Crisis, March 24, 2010 Fitoussi, J.-P. and F. Saraceno (2008), "Fiscal Discipline as a Social Norm: The European Stability Pact", Journal of Public Economic Theory, 10(6), pp. 1143-68. Fitoussi, J.-P. and F. Saraceno (2004). " The Brussels-Frankfurt- Washington Consensus. Old and New Tradeoffs in Economics " Document de Travail de l ’ OFCE, 2004-02