"Unconventional" Fiscal Policies

This commentary discusses heterodox fiscal policies that can be considered when use of conventional tools is precluded.

“Unconventional” Fiscal Policies

Biagio Bossone

Until the eruption of the Global Financial Crisis, macroeconomists agreed that fiscal policy was essentially unsuitable to manage aggregate demand and thus assigned to monetary policy the role to stabilize the business cycle (Bean et al 2010). The reasons invoked for rejecting fiscal policy as a stabilization tool typically included implementation lags, larger permanent deficits resulting in higher long-term interest rates and distortionary future taxes, and higher marginal propensities to save out of a temporary tax cut (i.e., lower income multipliers).

In fact, the crisis shook this old tenet as monetary policy proved ineffective at influencing nominal GDP when the zero lower bound (ZLB) constrained nominal interest rates and the economy was in a liquidity trap (Dotsey 2010). Such policy ineffectiveness, as well as the reluctance of governments to use prolonged fiscal stimulus to close large output gaps, eventually led central banks to undertake unconventional types of monetary policy that sought to revitalize economic growth by lowering interest rates on long-term riskier assets (Den Haan 2016).

Yet, the unclear efficacy of the new monetary policy levers and the uncertain consequences of the inflated central bank balance sheets that resulted from massive asset purchase programs prompted research to investigate alternative mechanisms to increase demand, especially in those countries (such as in southern Europe) where, years after the end of the Great Recession, growth was still sluggish. Such alternative mechanisms fall under three classes of “unconventional” fiscal policies (UFP):

  • pre-announced distortionary taxes
  • fiscal devaluations, and
  • fiscal money.

Each type of UFP is discussed in turn.

Pre-announced distortionary taxes

Drawing on earlier proposals,[1] Correia et al (2013) introduce a formal framework whereby engineering an increasing path of consumption taxes and a decreasing path for labor taxes, coupled with a temporary investment tax credit or a temporary cut in capital income taxes, generates households’ higher inflation expectations and negative real interest rates (Fisher equation);[2 ]the policy stimulates spending via intertemporal substitution effects that incentivize households to consume rather than save (Euler equation), and completely offsets the ZLB constraint.

This type of UFP differs from conventional fiscal policies in that it does not rely on income effects, is time consistent, and is budget neutral. D’Acunto et al (2018) note that this policy does not require inefficient commitments to keep future interest rates low, nor does it cause wasteful government spending. D’Acunto et al (2015, 2018) provide supporting evidence of the policy’s capacity to induce substitution over a very short horizon. In particular, by examining natural experiments in Germany and Poland in 2005 and 2010, respectively, the authors find that households behaved as predicted in response to a general increase in the value added tax (VAT) and document a positive correlation between households’ average inflation expectations and their willingness to purchase durable goods.

However, while successful at rapidly achieving the desired outcome, this type of UFP might be unable to drive the economy out of states of deep recession or stagnation. As Baker et al (2019) observe by studying the effects of sale tax changes in the US car market between 2009-2017, purchases (regardless of how they are financed) increase shortly before the tax increase, decrease immediately after the increase, and return to previous levels shortly after the tax increase. The policy, thus, only induces households to bring consumption forward in time while it does not raise consumption permanently, which is what would be necessary to achieve in an economy that is trapped in a persistent and deep state of recession, with price deflation or strongly anchored lowflation expectations. Furthermore, as Baker et al (cit.) emphasize, intertemporal substitution may be diminished by financial frictions, since households need wealth or credit to shift future expenditure to the present, but both wealth and credit decline during recessions when the fiscal stimulus is needed most.

In fact, the supposed strength of the pre-announced distortionary tax policy – its exclusive reliance on intertemporal substitution – may be its greatest limitation. As the policy involves no income effect, no demand shock is triggered to stimulate output and prices as conventional fiscal policies seek to do by allocating additional resources to those who can spend them (absent fully-offsetting Ricardian equivalence effects). And even if households are given greater access to credit (absent frictions), they end up with larger debt burdens and hence tighter intertemporal budget constraints. These limitations do not affect the other types of UFP discussed next.

Fiscal devaluations

This second type of unconventional fiscal policy (UFP) consists of a set of revenue-neutral fiscal instruments (e.g., tariffs and subsidies) that a country can use unilaterally to generate the same real outcomes as those following nominal exchange rate devaluations. Farhi et al (2014) show that a fiscal policy devaluation based on a uniform increase in import tariff and export subsidy is equivalent to one based on a VAT increase and a uniform payroll tax reduction.

This type of UFP is especially useful to stimulate growth in economies that participate in fixed exchange rate mechanisms or monetary unions. It offers a way to address divergences in competitiveness and trade imbalances without changing the nominal exchange rate, and it represents an attractive relaxation of Mundell’s “impossible trinity,” allowing for the same outcomes as under an active monetary policy while maintaining a fixed exchange rate and free capital flows.

The theoretical rationale for fiscal devaluations has been long established. Already in 1931, John Maynard Keynes proposed in the Macmillan Report to the British Parliament that a combination of a uniform ad valorem tariff on all imports plus a uniform subsidy on all exports be used to mimic the effects of an exchange rate devaluation while holding to the gold pound parity, and in the 1950s-60s as well as in the 2000s various countries used the tax system to duplicate the balance of payments impact of an exchange rate change.[3]

Earlier analysis of fiscal devaluations indicated that this policy is exposed to some critical challenges and risks, the most sensitive one being the nonuniform application of tariffs and subsidies and the consequent (potentially serious) distortion in relative prices that would compromise the essential neutrality of exchange rate changes for resource allocation (Laker 1981).[4]

More broadly, the arguments against fiscal policy devaluations are the same as those against conventional exchange rate devaluations, in particular, their long-run neutrality. Gopinath (2017) identifies the conditions under which the underlying fiscal actions are neutral – that is, they have no effect on real allocations – as when fully flexible prices adjust to undo the real effects of nominal exchange rate devaluations and argues that the instruments underpinning fiscal devaluations are not neutral in either the short or the long run and have significant consequences for international trade.

In fact, if a country were a partner to an exchange rate arrangement or a monetary union, the major limiting factor to its decision to undertake a fiscal devaluation would be political and, following Laker (cit.), one should wonder why a fiscal devaluation policy that would be as comprehensive in its coverage as a conventional nominal exchange rate devaluation should not evoke the same criticism or opposition as the latter, since the immediate impact of both policies on the trade balance would be identical.

Especially in the case of a large economy (relative to the overall size of the exchange rate mechanism or monetary union), its intention to adopt fiscal devaluation would likely face strong opposition from partners, precisely because such a policy would defy the very purpose for adhering to a fixed exchange rate mechanism or a monetary union. To a minimum, a process should be set up for coordinating such a decision with the partners and for determining the conditions under which such a policy could activated as an internal adjustment mechanism.

This limitation does not affect the third type of UFP.

Fiscal money

The introduction of fiscal money (FM) was advocated a few years ago by a group of Italian economists as a tool to overcome some of the consequences of Eurozone's dysfunctionalities. In particular, it was conceived for economies in recession or stagnation, which do not have control over monetary (and exchange rate) policy nor have space for undertaking active fiscal policies.[5]

FM is a transferable and negotiable security issued by government, which bearers may use for obtaining tax rebates two years from issuance. Such a security would carry immediate value, since it would incorporate a state commitment to accept it in exchange for reductions of future fiscal obligations. It would be instantaneously exchanged against euros or used as a payment instrument (parallel to the euro) in a dedicated platform where it would be accepted on a voluntary basis.

FM would be allocated, free of charge, to fund public investments and social spending programs, supplement employees' income and reduce businesses' tax-wedge (the difference between before-tax and after-tax wages) on labor. These allocations would increase and sustain a higher level of domestic demand and improve business competitiveness. The output gap would close without affecting the country's external balance. Similar to the fiscal devaluation discussed above, the reduction of the labor tax-wedge would mimic a nominal exchange rate devaluation and would be calibrated with the aim to keep the trade account balanced during the stimulus. By neutralizing the effect on imports of the demand stimulus, the labor tax-wedge reduction would also prevent the erosion of the income multiplier effect, whose value would be closer to that of a “closed” economy.

Using conservative estimates of the income multiplier and investment accelerator effects for the Italian economy, a FM program could cross the economy to a higher and steady growth path, generate sufficient tax revenues to offset the deferred tax rebates coming due, and allow public debt to progressively decline relative to GDP.[6] Note that the deferral is built in the FM securities precisely to allow the new spending following their issuance to stimulate output and generate the fiscal revenues need to cover the cost of the tax rebates.

The crucial assumptions underpinning the effectiveness of the FM proposal are the income multiplier and the investment accelerator. While estimates of the former vary considerably, the recent empirical research prompted by the recession following the Global Financial Crisis abundantly shows that the value of the is exceedingly is large during periods of economic recession or prolonged stagnation.[7] As regards the investment accelerator, its (long forgotten) relevance has been re-emphasized by Furman (2015).

The FM program would be protected from the risk of fiscal underperformance by specific safeguard measures. Specifically, if the program temporarily underperformed (in that it would create less revenue than what would be needed to cover the tax rebates), policymakers would pre-commit to restoring fiscal compliance. This could be achieved by financing select public investment with FM (instead of euros), raising taxes and simultaneously allocating additional FM securities, incentivizing FM holders to reschedule their use for tax rebates by enhancing their value, and placing FM securities in the market (in exchange for euros). These measures would raise the needed euro-cash while avoiding procyclical effects. Importantly, they would prevent market uncertainties. Moreover, a high cover ratio (that is, the ratio between government gross receipts and the tax rebates coming due on redemption of the FM securities) would make them sustainable.

Finally, one of the most common objections to the FM proposal is that the issuance of FM securities would create budget deficit and debt, which would cause a country adopting it to violate the EU fiscal rules. This is not so. First, according to the International Financial Reporting Standards, the FM securities would not constitute debt, since the state as issuer would be under no obligation to reimburse them in future. Second, as 'non-payable' deferred tax assets (DTAs), under the European System of Accounts, FM securities would not be recorded in the budget until used for tax rebates, that is, two years after issuance (ESA 2010). Finally, non-payable DTAs do not fall under the definition of the Maastricht debt and are not recorded in the related official statistics.[8]


The Global Financial Crisis and its severe and persistent consequences for many advanced economies have manifested the inadequacy of traditional macroeconomic tools to revamp output and employment under some extreme but plausible conditions, such as very high liquidity preference across agents or limited (or exhausted) space for the use of active fiscal policies.

Both on the monetary and fiscal front, alternative – “unconventional” – instruments have been designed to overcome the shortcomings of conventional policies, and to assist troubled economies in recovering better levels of economic performance.

The discussion above aims to raise the attention of the economist international community to various existing policy alternatives, which should be considered when other avenues are precluded.


Baker, S, L Kueng, L McGranahan and Brian T. Melzer (2019), “The interaction of household finances and unconventional fiscal policy,” Vox, 30 January.

Bean, C, M Paustian, A Penalver and T Taylor (2010) “Monetary policy after the fall,” Proceedings, Economic Policy Symposium, Jackson Hole, 267-328.

Bossone, B (2015), “La moneta fiscale: un inquadramento nell’attuale contesto di policy di Biagio Bossone, in Bossone et at (2015), Ch. V, 79-107.

Bossone, B and M Cattaneo (2018), “New ways of crisis settlement: Fiscal Money as a tool to fight economic stagnation,” paper presented at the conference on “A single model of Governance or tailored responses? Historical, economic and legal aspects of European Governance in the Crisis,” FernUniversität in Hagen, Germany 24 – 25 November 2016, published in Schiffauer (2018).

Bossone, B, M Cattaneo, M Costa and S Sylos Labini (2017), “Moneta Fiscale: il punto della situazione,” MicroMega, 17 giugno.

Bossone, B, M Cattaneo, L Gallino, E Grazzini and S Sylos Labini (eds.) (2015) “Per una nuova moneta fiscale: uscire dall’austerità senza spaccare l’euro,”, e-book MicroMega, 15 giugno.

Cattaneo, M and G Zibordi (2014), “Una soluzione per l’euro: gli strumenti per rimettere in moto l'economia italiana”, Hoepli Editore, marzo.

Correira, I, Farhi, E, J P Nicolini and P Teles (2013), “Unconventional Fiscal Policy at the Zero Bound”, American Economic Review 103(4), 1172-1211.

D'Acunto, F, D Hoang and M Weber (2015), “Inflation expectations spur consumption,” Vox, 9 June.

D’Acunto, F, D Hoang and M Weber (2016), “The Effect of Unconventional Fiscal Policy on Consumption Expenditure”, NBER Working Paper No. w22563, August.

D'Acunto, F, D Hoang and M Weber (2018), “Unconventional Fiscal Policy.” AEA Papers and Proceedings, 108, 519-23, May.

Den Haan, W (ed.) (2016), “Quantitative Easing: Evolution of economic thinking as it happened on Vox,” a VoxEU.org eBook, CEPR Press.

Dotsey, M “Monetary Policy in a Liquidity Trap,” Business Review Q2, Federal Reserve Bank of Philadelphia.

Engler, P, G Ganelli, J Tervala, S Voigts (2017), “Fiscal Devaluation in a Monetary Union,” IMF Economic Review, June, Volume 65, Issue 2, 241-272.

ESA (2010), “Treatment of Deferred Tax Assets (DTAs) and Recording of Tax Credits Related to DTAs in ESA 2010), Eurostat Guidance Note, European Commission, Eurostat, 29 August 2014.

Farhi E, G Gopinath and O Itskhoki (2014), “Fiscal Devaluations,” Review of Economic Studies, April 2014, 81(2), 725-760.

Feldstein, M (2002), “The role for discretionary fiscal policy in a low interest rate environment,” NBER Working Paper Series, Working Paper 9203, National Bureau of Economic Research, September.

Furman, F (2015), “Business Investment in the United States: Facts, Explanations, Puzzles, and Policies,” Remarks by Chairman, Council of Economic Advisers, at the Progressive Policy Institute Washington, D.C., 30 September.

Gopinath, G (2017), “A Macroeconomic Perspective on Border Taxes,” Brookings Papers on Economic Activity, Fall.

Hall, R E (2011) “The long slump,” American Economic Review 101 (2), 431–469.

Laker, J (1981), “Fiscal Proxies for Devaluation: A General review,” IMF Staff Paper, March 1981, Volume 28, Issue 1, 118-143.

Schiffauer (ed.) P (2018), A single model of Governance or tailored responses? Historical, economic and legal aspects of European Governance in the Crisis,” Veröffentlichungen des Dimitris-Tsatsos-Instituts für Europäische Verfassungswissenschaften, Band 19, Berliner Wissenschafts-Verlag, pp. 111-133, June.

Shapiro, M D (1991) “Economic stimulant: Sales Tax,” New York Times, 16 December.


[1] See, for instance, Shapiro (1991), Feldstein (2002), and Hall (2011).

[2] Correia et al (cit.) denominate this policy as “unconventional fiscal policy.” However, recognizing that there are other, profoundly different types of heterodox fiscal policies, this commentary uses the term “unconventional” to qualify them all under one whole family, and defines each of them by pointing to a specific key feature that uniquely characterizes it. Also, qualifying all such policies as “unconventional” reflects on the fiscal front the same characterization used for the heterodox monetary policies run by central banks at the ZLB.

[3] Laker (cit.) analyzed the earlier episodes, which include France (1957-58), Israel (1955-62), India (1963-66), the Federal Republic of Germany (1968-69), and France (1957-58), and noted that fiscal devaluations had taken place in a number of Latin American countries. More recently, fiscal devaluation policies have been implemented by Denmark (1988), Sweden (1993), Germany (2006), and France (2012).

[4] As Laker (cit.) evinced from the past episodes analysed (see previous footnote), in many instances fiscal proxies were not applied uniformly, but on a selective and discriminating basis. Even in the case of France, where the policy had a comprehensive coverage, the tax and subsidy scheme adopted applied to about 60 percent of all imports (excluding coal, petroleum products, and major raw materials), about 65 percent of all exports (excluding iron and steel products, textiles, the latter being covered later), and all other transactions.

[5] Fiscal money is broadly defined, as “any claims, private or public, which the state accepts from holders to discharge their fiscal obligations either in the form of rebates on the full value of the obligations or as effective values transfers (i.e., payments) to the state. Fiscal money claims are not legal tender and may not be convertible by the state in legal tender. However, they are negotiable, transferable to third parties, and exchangeable in the market at par, or below par, with respect to their nominal value” (Bossone and Cattaneo 2018). The FM proposal was originally introduced by Marco Cattaneo (see Cattaneo and Zibordi 2014). The proposal was further elaborated by Bossone et al (2015, 2017), which also analyses its economic, institutional, legal, and accounting aspects.

[6] Projections are reported in Bossone and Cattaneo (2018).

[7] For an extensive review of the recent literature, see Bossone (2015). While the article is in Italian, non-Italian reading readers may still find useful the references therein reported.

[8] Official statistics on national Maastricht debts do not record governments’ non-payable tax credits that are issued for sectoral purposes (e.g., property renovation, past losses, depreciation of assets), can be used for tax settlement, but do not involve debt repayment obligations for the issuing government.