Given the nature of European inflation – a supply shock – the role of fiscal policy is crucial to target and moderate the impact of monetary policy. Every fiscal measure should consider the impact on fiscal deficit, strategic autonomy and productivity to address structural causes of inflation.
We have listened to the Treasury’s outlook for Italy. We know that the International Monetary Fund forecasts for the European Union are two quarters of contraction, following the monetary policy measures to reduce inflation. Central banks cannot do differently despite the fact EU inflation is caused mostly by energy shocks, even though the size of the rate increase is up for debate as well as the timing of balance sheet reduction.
Fiscal policy should not offset the working of monetary policy, but it can target and moderate its impact. Spending to offset the increase in energy bills for the most energy-dependent companies and the most vulnerable households is justified. However, the present Italian government seems willing to shield all households and companies – whether this is viable or not.
The tax of the Mario Draghi government was not extended to the end of the year. But now, and only for 2023, the windfall tax seems to be back. As yet undecided, it is predicted to be between 25% and 50% of excess profits of energy companies over the average of the last four years, including 2022, under a ‘temporary solidarity contribution’.
The decision to provide non-targeted state support to offset electric bills is a mistake for several reasons. First, the electricity price is determined by the marginal price (gas price) Therefore, it contains a huge element of rent intended to provide an incentive to invest in renewables. Since August 2021 and Vladimir Putin’s energy war against Europe, this rent has increased by 600% – even more before the summer. Second, we need the price signal to incentivise investments in renewables by households and encourage energy saving.
With households’ real income decreasing and stocks and bonds not performing well, demand has to rely mostly on public investments. Still, huge private savings can be mobilised for shared objectives, as with home energy efficiency incentives.
Italy is the beneficiary of the largest recovery and resilience national plan with investment projects and reforms designed by the Draghi government. There is around €60bn in the Italian RRNP for the ‘ecological mission’, but the timing for these investments was decided before the war and has a 2025 deadline.
The funds for green investment and the digital transition, which support each other, should be pushed forward, because the incentives for renewables can make a difference for families, businesses and the state now, reducing the demand for gas and therefore its price and inflation.
We have the skills and private wealth to start covering the roofs of our cities with solar panels.
These incentives, in the present context of high energy prices and uncertainties about availability of fossil fuel energy, are the real alternative to carbon taxes to advance energy transition.
The causes of present-day inflation are in part structural – not only transitory as some believe. The same is true for energy. After 30 years of downward pressure on prices due to China’s entry, there are fewer new entrants to the global market, while the working-age population of advanced countries shrinks. Thus, the deflationary pressure on prices (and on the real interest rate) has also ended. Geopolitics has pushed into economics and forces us to friend-shoring, which will also increase prices.
While in the past Germany could ignore the lack of demand in Europe by exporting to China, it now knows that Europe’s strategic autonomy is an existential goal, not just for energy and defence. This helps to explain the revolution of the new European fiscal rules presented by the Commission in November.
While central banks do their job against inflation, we need to invest in innovative sectors aiming at strategic autonomy in the high tech industry. These investments increase total productivity, therefore reducing inflation without interrupting growth.
A greener EU can attract the flows of green finance. Moreover, exporting the knowhow of the green transition to countries like those around the Mediterranean can be done by blending public, private and multilateral banks’ funds. Let’s remember that these are the countries of departure of migrants to Europe.
Gloria Bartoli is Secretary General, Observatory on Productivity, Fondazione Tor Vergata.
This article is adapted from a speech given at an event hosted by OMFIF in November.