BlogSpot - November 3rd, 2014
- warningsignals
- Nov 3, 2014
- 4 min read
Has the European Union reached a point of no-return?
For Anatole Kaletsky, Europe is at a make or break moment (Reuters). With a risk of deflation estimated at 30% by the IMF and disappointing growth, Guntram B Wolf writes that the stability of the European Union is challenged by economic and political constraints to policy effectiveness, impeding the return to a solid growth path (Project Syndicate).
Controversial fiscal policy in Europe
The fiscal debate re-opened with the European commission’s verdict on the French and Italian budget for 2015. Both countries presented measures to reduce their deficit further (Anatole Kaletsky, Reuters). Vice President Katainen cleared both governments of “particularly serious non-compliance” with the SGP. Sanctions may still come as other European countries, including Germany, would have to approve the members’ budget, as noted by Peter Spiegel in the FT. Eurointelligence reminds us that France still needs to obtain another permission for a delay to achieve a deficit below the 3% of GDP – after being granted already a two-year delay in 2013. For this, the commission must determine the French government has implemented significant economic reforms, and the waiver would require approval from other eurozone countries, including Germany.
Opinions diverge on the flexible treatment granted by the European Commission to these euro area countries, even inside the Commission. Karel De Gucht, outgoing Commissioner, questions the French commitment to the European framework. Ashoka Mody criticizes the efficiency of the European fiscal measures on weak economies, as he thinks that austerity is counterproductive and self-defeating (Bruegel). This raises the question of whether the European Union should stick to traditional fiscal policies when facing risks of stagnation. For Giuseppe Guarino (hat-tip Eurointelligence), the stability pact violates the Maastricht Treaty’s initial objective of sustainable growth.
Anatole Kaletsky suggests that fiscal rules’ reinterpretations or transformations are required to avoid a break-up of the monetary union. Ashoka Mody is more optimistic as France and Italy disagreement with the European fiscal budget can inspire new protests from other European members and therefore discredit the austerity fiscal target. He requests the end of the centralization of fiscal rules that has no political nor economical sense and suggests to resort to automated debt restructuring with a dynamic ECB that would prevent financial contagion (Bruegel).
On the sidelines, the UK experienced its own budget dispute with the EU, being asked to pay an additional £1.7bn due to the re assessment of its economic performance—leading to strong criticisms and suggestions of “Brexit”, as presented by Iain Begg. Chris Giles and Alex Barker report the Prime Minister’s anger facing the sudden appearance of the bill (FT, The Guardian)—David Cameron suggested that he would not pay the additional contribution but faces a clear request from the European commission (Project Syndicate). Giles and Barker explain that this budget surcharge results from a systematic under-recording of the size and contribution of the charitable sector due to an inconsistent application of the old ESA95 rules rather than recent revision to GDP statistics (FT).
The sustainability of European monetary policy over the long run
Analysts are asking whether the risk of chronic deflation in the eurozone may be as dangerous as the risk of a euro break-up at the height of the crisis. Eurointelligence argued that if the slide into deflation becomes chronic in the eurozone, countries would likely be eager to leave from this monetary union and to avoid the economic disaster by devaluing. Olli Rehn and Jean Arthuis (FT) write that it is crucial for the ECB gear its monetary policy to counter-balance deflation, including with quantitative easing, and act as a lender of last resort in the banking system.
Progress on the banking union is an important component in the fight against deflation. Financial fragmentation remains a worry, as stressed by Paul Krugman, with large differences in borrowing costs between Northern and Southern private sectors, even if the spread for governments’ borrowing costs has been largely reduced since the debt crisis. Such asymmetric costs imply that the risk of breaking apart is still present. Simon Wren-Lewis from Mainly Macro highlights these inter-country differences by looking at the evolution of the nominal wage growth in the eurozone between 2000 and 2007. On the positive side, Martin Wolf, in a FT article, notes that the recent stress tests address concerns about the banking sector in Europe but this is not sufficient for stabilizing the economy and eliminating the risk of the deflation—which depends ultimately on the ability to engage into QE.
Willem Buiter (FT alphaville) is less optimistic, describing the AQR as an «unconvincing fudge.» According to him, the EBA has underestimated the capital shortfall in the European banking system characterized by too many disparities between the member states. He advocates for recapitalizing capital-deficient banks to create a more effective competition system accompanied by a temporary expansionary fiscal policy financed by the ECB, thanks to the purchases of government debt (Sovereign QE), and structural reforms.
Koichi Amada (Project Syndicate) goes back to the root of the problem, i.e., imposing a monetary union on heterogeneous countries when the euro was adopted in 1999, quoting from Martin Feldstein. According to Feldstein, the eurozone is a “failure” due to the non-respect of the criteria for an optimal currency area and the intern issues in the eurozone governance. Feldstein argues that some member countries need to have an independent monetary policy to solve their long-term differences of productivity growth and competitiveness.
The Short View...
Pact signed by 51 countries to tackle the tax evasion. Fifty-one countries signed the OECD pact to halt the tax evasion. Wolfgang Schäuble (Project Syndicate) underlined that the importance of resolving the tensions between national fiscal sovereignty and cross-borders business activities through a global action.
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