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posted on 19 November 2016

Eurozone: The Stability And Growth Pact Is Dead.

from Dirk Ehnts, Econoblog101

As Reuters reported three days ago, the EU has decided not to punish the governments of Spain and Portugal for running deficits that were higher than the EU demanded:

The European Commission said on Wednesday it will not suspend EU funds for Spain and Portugal next year following their breach of EU budget rules, as it also called for looser fiscal policy across the euro zone.

The European Union’s executive Commission has the power to impose fines and to suspend EU funds for countries that run deficits above 3 percent of their gross domestic product and do not take measures to correct their excessive gaps.

Spain and Portugal were found in breach of EU fiscal rules last year, but the Commission has concluded there is no need to sanction them as they have taken sufficient measures to correct their imbalances, Commission vice president Valdis Dombrovskis told a news conference.

So, it should not come as a surprise that European politics is, well, political. Greece is now the only country where the rules are applied harshly (and unfairly, I think), whereas the others seem to be free to increase government spending. Any future punishments can now be attacked by referring to what happened (or rather not happened) to Spain and Portugal.

Finally, Keynesian thought has replaced neoclassical thought at Brussels! Austerity in times of crisis is, was and always will be a bad idea, if you have no outside option to export lots of stuff to other trade partners. However, not everybody thinks like this. Daniel Gros,Director of the Brussels-based Center for European Policy Studies, at Project Syndicate had noticed the death of the Stability and Growth Pact a few weeks ago, writing:

But the decline in support for European fiscal rules carries serious risks. If the most concrete elements of the eurozone’s governance framework are not applied rigorously, what will compel member states to undertake reforms and stabilize their debt levels? Vague exhortations will not work. It seems that the crisis, and the untenably large risk premia for highly indebted governments that followed, has already been forgotten.

Officially, the Commission is still working to realize the blueprint for a “genuine" Economic and Monetary Union. But in the wake of the Commission’s decision not to enforce the SGP, this effort has become meaningless. It is now clearer than ever that EU member states prioritize domestic political imperatives over common rules - and Europe’s common good.

I do not agree with these statements at all. Stabilizing public debt levels is not a feasible economic policy in any case, because in the pursuit of one number - public debt to GDP - you lose sight of the real world. In Spain, an old lady died this week after a candle started a fire at her place and she fell down when trying to run away. Why was she using a candle? Because the electricity company had cut her off for not paying her bills. So, in Western Europe, we have households now that have no electricity. That is ridiculous! Are we so poor that we cannot afford to provide electricity to the elderly? No, we are not. This is a political choice and the decision that caused this was to cut government spending because of this sad ideology of expansionary austerity.

Untenably large risk premia for highly indebted governments"? That was a mistake, and it has been corrected. Now the ECB will make sure that bond yields will not rise if “the market" starts to doubt a government. It was wrong to give so much power to financial markets and to let them punish governments. In the end, they would have punished all governments and driven them into bankruptcy if during the crisis we would not have interfered with the market by changing the governance of the eurozone.

EU member states, as I see, prioritize meaningful domestic political imperatives like fighting unemployment over meaningless common rules like the Stability and Growth Pact, which only have been put in place to increase the power of the financial sector.

The death of the Stability and Growth Pact is a good thing. However, it is only the first step in the right direction. More will have to follow before the next recession hits the eurozone and destroys the single currency.

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