BlogSpot - October 22nd, 2014
What appropriate fiscal stance for European economies?
The spectre of financial sanctions against France for failure to correct its excessive deficit by 2015 (4.3% next year – above the promised 3%) re-opened the fiscal policy debate in Europe, and raises the issue of the flexibility provided by the Stability and Growth Pact to national governments (Notre Europe). Jeroen Dijsselbloem, the President of the Eurogroup, warned that there should be "no deals outside the pact". The French government is proposing a two-year delay to meet budget targets, as Real Time Brussels reports. Four other countries have been sent warnings by the European Commission for their fiscal stance (FT).
John Bruton, in Project Syndicate, defends the EU framework for coordinating the 18 eurozone members’ budget policies (the so-called Two Pack and Six Pack), including the continuation of consolidation policies. He argues that non-compliant indebted eurozone countries would face the risk of increasing interest rates on governement bonds, especially when debt traps may appear due to inexistent inflation, low economic growth and thus high exposure to sovereign default. Others, like Wolfgang Munchau, are more pessimistic, believing that fiscal policy remains fundamentally national.
Stimulus-versus-austerity is an old debate, as Harold James notices in Project Syndicate, and reflects philosophical differences between the US and Europe, the former urging Europeans to do more to boost their anemic growth rate. The main question is : under which conditions deviation from fiscal orthodoxy might be stabilizing in the long term ?
Self-defeating fiscal discipline
The importance of fiscal stabilizers… The IMF World Economic Outlook, stresses that additional consolidation efforts should not be triggered by large negative growth surprises, especially in the euro area—as this would be self-defeating.
The policy mix depends on effective fiscal policy… Paul Krugman highlights the severe political constraints for expansionary monetary policy in a world of fiscal austerity and structural reforms—it hobbles quantitative easing and reinforces the liquidity trap.
A new "growth deal" through investment (Reuters)… could be achieved with more fiscal wiggle room and low-interest EU funds in exchange of ambitious economic reforms. Loosening up the fiscal stance could be effected through public investment, and European-level approaches are advocated, notably greater EIB investment (Bruegel). This would address a lasting demand shortage in Europe, compounded by structural problems to resolve with suitable supply-side reforms (Bruegel).
Public investment as a magic wand
Public investment in the eurozone experienced years of decline—scaled back from about 4% of GDP in the 1980s to 3% of GDP at present (Bruegel), creating what could be called the euro area’s “investment gap” of €800 billion. Although the European Investment Bank has played some counter-cyclical role during the crisis (in an order of magnitude of about 0.3 percent of EU GDP in 2007-2009), it now plans to reduce investments to €67 billion in 2014 and 2015, to €58.5 billion in 2016 (see the EIB’s three-year Corporate Operational Plan). Paul Krugman talks about disinvestment madness in a depressed economy: real interest rates are extremely low, indicating that the private sector sees very little opportunity cost in the use of funds for public investment (i.e., no risk of crowding out).
Public investment could both address the demand shortage and the need to boost potential growth. The IMF (WEO chapter 3) highlights both the short- and medium-term effects of public investment on a range of macroeconomic variables (not only the long term effectus)—with one key finding: even debt-financed public investment reduces public debt over the medium-term. Jeremie Cohen-Setton (Bruegel) notes in a review of blogs that the time is now for an investment push. At the European level, the new Commission could propose updating the rules for fiscal discipline, and reflect the role of productive public investment.
Solutions are being sought out in the Eurozone in order to break these deadlocks. Jean-Claude Juncker proposed a €300 billion investment plan over 3 years, as Matthew Dalton highlights in Real Time Brussels. Though its funding is being questioned (Euro Intelligence): it has not been decided how much the public sector will contribute, and the private-sector money, i.e raising funds on financial markets, is not guaranteed. Further, the AAA-rating limits any risk taking. Wolfgang Munchau suggests to either force a change in the EIB’s model or raise funds through a highly-levered investment vehicle whose securities are subsequently bought by the ECB.
Germany’s "prestige" fiscal policy
New indicators of Germany’s economic performance are casting new doubts on its solidity (see our WarningSignals BS on Weakness at the Core), according to Eurointelligence. Martin Wolf, in a FT Column, goes further and argues that structural reforms in Germany brought unemployment down but generated no growth. Analysts are suggesting going beyond a large trade surplus that supports low unemployment rates (Paul Krugman)—with greater investment benefiting Germany itself, regardless of the rest of the Eurozone, as argued by Christian Odendahl. The current environment reinforces this call for larger investment: with record low borrowing costs and a slowing growth.
The overall quality of infrastructure is declining. German investment has been falling steadily over the past two decades and by international comparison, the country has not been investing enough in infrastructure, nor education or R&D (see Christian Odendahl in medium.com).
Germany can afford public spending. According to the IMF WEO, Germany is the only large surplus economy to experience a widening of its surplus, and could afford to finance public investment in infrastructure. Odendahl notes that over the next few years the government will be able to borrow for free in terms of real interest rates.
This contrasts to the government’s 2015 budget and its zero deficit target, a prestige policy according to the German Economic Institute (Eurointelligence). The supporters of fiscal discipline (for example Holger Steltzner in FAZ) stress the importance of structural reforms to lead growth. Wolfgang Münchau (FT) writes that it would take far more than a few quarters of weak economic growth to make Germany shift its position on fiscal stimulus—maybe only a large market labor crisis.
By Youna Lanos and Ghita Lamriki
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