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Whether and how this virtuous cycle can be triggered in the EU is a first order issue. IMO, this is one of the most interesting research and policy questions of our times.

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This amplification effect could also go in reverse. A 'pro-growth' fiscal reform could raise productivity growth, making public debt easier to sustain, in turn freeing fiscal space for even more pro-growth policies.

Martin Wolf and I have studied this amplification effect in a recent paper, and show that it may lead to a state of fiscal stagnation, characterized by a self-sustained vicious cycle of high debt, high fiscal distortions and low productivity growth. Italy may be an example of it.

If the drop in public investment has a strong negative impact on productivity growth, the future public debt to GDP ratio may end up raising. This will call for another round of fiscal adjustment through cuts in public investments, and so on.

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Moreover, there may be an amplification effect at play. Imagine that a government cuts public investments to increase its surplus and stabilize its debt (pretty much what happened during the euro area sovereign debt crisis).

There is also evidence suggesting that taxes on investment in intangibles tend to slow down innovation and productivity growth. While this evidence is preliminary, it thus does look like fiscal policy affects productivity growth.

On the empirical side, recent research suggests that public investments matter for productivity. In particular, these two brilliant papers show that higher spending in public R&D crowd in private investment and lead to higher productivity growth in the medium run.

My feeling is that this may be a big miss, and that integrating endogenous productivity dynamics in debt sustainability analyses could be an important area for future research. Let me explain by citing a few recent works.

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Are public debts in the European Union sustainable? This recent article is a great introduction to this topic, I learned a lot by reading it. One thing that struck me is that debt sustainability analyses typically abstract from the impact of fiscal policy on productivity growth.

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If you're interested, you can find the full paper here crei.cat/wp-content/u.... @mw_econ and I are pretty new to the international trade literature, so comments are welcome.

crei.cat

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Finally, what if a country puts a tariff on innovation inputs, perhaps by taxing researchers moving from abroad? This policy may fail spectacularly, by triggering an outflows of innovation goods, which over time will erode the country's technological rents.

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Moreover, if the rest of the world chooses to retaliate, the result will be a full-blown trade war. In this scenario, tariffs have no impact on the distribution of technological rents across countries, but they cause big efficiency and output losses.

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But this strategy has several drawbacks. First, reducing imports of foreign high-tech goods generates productivity and output losses. Second, even if import tariffs may increase national welfare, this comes at the expense of even larger welfare losses in the rest of the world.

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Tariffs on imports of high-tech goods may be used to steal technological rents from the rest of the world. Intuitively, tariffs reduce the profitability of foreign high-tech firms, causing a flow of innovation inputs and technological rents to the country imposing the tariffs.

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From a national perspective, importing innovation inputs yields technological rents, because of the positive knowledge spillovers that they create. So countries have an incentive to compete for technological hegemony, i.e. to become net importers of innovation inputs.

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To innovate, high-tech firms need specialized 'innovation inputs', such as researchers and venture capital. Building a strong high-tech cluster requires importing innovation inputs from abroad. Think of foreign researchers working for Big Tech firms in the Silicon Valley.

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We start from the observation that high-tech clusters generate technological rents for the countries hosting them. Not only high-tech firms are highly profitable, but their innovation activities trigger positive knowledge spillovers to other domestic firms.

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We provide a framework connecting trade policies to innovation and technological hegemony. Our model focuses on high-tech firms that invest heavily in R&D and other intangibles. Nowadays, these firms play a key role in international trade.

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Luca Fornaro @lucafornaro.bsky.social · 23/09/2025

How will tariffs affect innovation in the US and abroad? Shall the EU use tariffs to protect its high-tech industries? Should the rise in Chinese exports of high-tech goods worry the rest of the world? We tackle these issues in a new paper on Tariffs and Technological Hegemony.

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Some thoughts on the interactions between public debt, public investments and productivity growth in the euro area. Key risk is that the union ends up being split between a fiscally sound/high growth block and a fiscally stagnant one. www.ecb.europa.eu/pub/pdf/sint...

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Luca Fornaro @lucafornaro.bsky.social · 31/07/2025

Spain during the 2000s is a good example of these dynamics, but productivity growth slowdowns during large surges in trade deficits are quite common.

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Luca Fornaro @lucafornaro.bsky.social · 31/07/2025

Is the EU heading towards a financial resource curse? Cheap imports (and capital flows) from China could crowd out economic activity in tradable industries in the EU, causing a productivity growth slowdown. crei.cat/wp-content/u...

crei.cat

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Luca Fornaro @lucafornaro.bsky.social · 03/07/2025

Here you can find the full slides ecb.europa.eu/pub/pdf/sint..., while here is the recording of the panel ecb.europa.eu/press/confer..., which features great contributions by @isabelschnabel.bsky.social, @agnesbq.bsky.social, @pietphc.bsky.social and @refetgurkaynak.bsky.social.

ecb.europa.eu

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Luca Fornaro @lucafornaro.bsky.social · 03/07/2025

Deeply honored to have participated in a panel at the @ecb.europa.eu Forum in Sintra. My remarks focused on the risk that high legacy debt may push part of the euro area into fiscal stagnation, and how a pro-growth approach to fiscal policy can mitigate this risk.

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Reposted by Luca Fornaro

Matteo Sartori @matteosartori.bsky.social · 02/07/2025

This Macro-Musings episode 🔈 podcasts.apple.com/it/podcast/m... featuring @lucafornaro.bsky.social provides extremely insightful and clear views on macroeconomic policies to counter hysteresis and stagnation 📈

podcasts.apple.com

Luca Fornaro on Hysteresis, Endogenous Growth, and Aggregate Demand Policies

Puntata podcast · Macro Musings with David Beckworth · 19/05/2025 · 1 h

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Reposted by Luca Fornaro

Rudi Bachmann @bachmannrudi.bsky.social · 26/06/2025

Enjoyed very much this podcast with MacroMusings and @lucafornaro.bsky.social about endogenous growth and aggregate demand policies. youtu.be/B7aRTPgepok?...

youtu.be

Luca Fornaro on Hysteresis, Endogenous Growth, and Aggregate Demand Policies

YouTube video by Mercatus Center

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Reposted by Luca Fornaro

David Beckworth @davidbeckworth.bsky.social · 10/06/2025

What do powerlifting and economic hysteresis have in common? My latest newsletter explores this connection, building on @petercontibrown.bsky.social Conti-Brown's powerlifting journey and @lucafornaro.bsky.social's hysteresis research. macroeconomicpolicynexus.substack.com/p/let-it-fai...

macroeconomicpolicynexus.substack.com

Powerlifting through Hysteresis

On strength lost, strength regained, and the scars that shape an economy.

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Reposted by Luca Fornaro

VoxEU @ CEPR @voxeu.org · 02/06/2025

@lucafornaro.bsky.social & Martin Wolf argue that a feedback loop is possible between fiscal policy and #growth. Exiting fiscal stagnation requires large policy interventions that reduce public debt-to-GDP ratio, such as credible pro-growth strategies. cepr.org/voxeu/column... #EconSky

Three graphs of the evolution of public debt, primary surplus, and productivity growth in Italy compared to other advanced economies.

Public debt-to-GDP ratios have climbed to historic highs in most advanced economies. This column studies the connection between productivity growth, fiscal policy, and public debt. Using a theoretical model, it argues that a feedback loop is possible between fiscal policy and growth. Large primary surpluses are associated with fiscal distortions which depress investment and productivity growth, and lead to further pressure on public debt-to-GDP ratios. A fall into fiscal stagnation can result from hysteresis effects or pessimistic animal spirits. Meanwhile, exiting fiscal stagnation requires large policy interventions that reduce the public debt-to-GDP ratio, such as credible pro-growth strategies.

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Taking stock, our paper suggests that fiscal stagnation is a tangible risk, and avoiding/escaping it requires that fiscal authorities design credible pro-growth fiscal plans. Here's a link to the paper mwolfunisg.github.io/website/fist.... It is still preliminary, so comments are welcome.

mwolfunisg.github.io

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Pro-growth policies are more appealing. Credibly promising to lower fiscal distortions boosts investment and growth. High growth, in turn, reduces the debt-to-GDP ratio. But, due to a time-consistency problem, this strategy requires commitment on the side of the government.

Austerity, in theory, is simple. Increase the primary surplus today to lower public debt in the future. But austerity discourages investment and growth. So exiting stagnation through austerity is painful and takes a long time, especially if animal spirits are pessimistic.

How to optimally escape fiscal stagnation? First, marginal policy changes won't do it. Exiting stagnation requires a big push, i.e. a large change in fiscal policy to reduce the public debt-to-GDP ratio. Two strategies to do so: fiscal austerity and pro-growth policies.

A shift from fiscal soundness to stagnation can be interpreted as the result of self-defeating austerity. During the transition toward fiscal stagnation, in fact, high primary surpluses depress growth so much that the debt-to-GDP ratio may not decline, or even rise.

What makes the economy fall into fiscal stagnation? This may happen through hysteresis effects, i.e. a moderate negative fiscal shock may lead to a sharp deterioration of the long-run fiscal outlook. But pessimistic animal spirits can drive the economy into fiscal stagnation too.

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Due to this feedback loop, the economy may enter a fiscal stagnation steady state, i.e. a self-perpetuating state of high fiscal distortions and weak growth. Technically, our model has multiple steady states. so a fiscally sound and a fiscal stagnation steady state may coexist.

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Our model suggests that this is a risk, because of a feedback loop between fiscal policy and growth. Large primary surpluses and high fiscal distortions depress investment and growth. But low growth calls for high primary surpluses to ensure the sustainability of public debt...

Let's start from Italy. Since the early 1990s, Italy had to post high primary surpluses - high taxes + low public investment - to sustain its public debt. Over this period, productivity growth slowed down dramatically. Will other high-debt countries face a similar scenario?