Written by Hilary Barnes
The European Commission, possibly owing to pleading by France’s President François Holland, possibly because the German government has changed its stance, or possibly on its own initiative, has eased the terms on which budget stabilisation policies must be implemented by the Eurozone countries.
Many commentators have been quick to conclude that this marks the end of the Europe’s austerity policy, or at least the beginning of the end, but this is a mistake. The commission has not abandoned austerity policy, as its high priests continue to repeat, only eased it a little.
What the countries concerned have got is a breather in their progress from the first to the second stage of austerity policy, with the second stage introducing what is to all intents and purposes a policy of permanent austerity for countries with high debt to GDP ratios.
While the easing of the budget deficit reduction rules could be made by stretching the elastic that is built into the Eurozone Stability Pact, there is no such elastic in the rule for the second stage. If this is to be changed, then treaty changes will be required (unless the treaties are simply ignored).
The Stability Pact contains two rules: the general budget deficits of member countries must not exceed 0.5 % of GDP; if debt to GDP ratios exceed 60 % of GDP, the ratio must be reduced each year by one twentieth of the difference between the actual debt and the 60 % level.
None of the countries concerned has reached this point yet because they are all still in the process of reducing the budget deficit first to 3.0 % of GDP and then, when that hurdle has been passed, to 0.5 %.
For the sake of the arithmetic, let’s say that France had reached the 0.5 % maximum in 2012. It has a GDP of about €2,000bn (two trillion) and a debt to GDP ratio of about 90 %. That would have left it with a difference of 600bn between the 60 % ratio and 90 %. One twentieth of 600bn is 30bn, which is about 1.5 % of GDP.
So France would need GDP growth of 1.5 % just to keep the debt ratio stable, and the drag on growth would be considerable, depending on the whether the multiplier is a harsh 1 or a less harsh 0.5, or whatever.
Other dynamics that have to be factored into this simple example, too. The debt to GDP ratio is against nominal GDP, so a bout of inflation would help reduce the debt ratio. But inflation would not be good for export growth, unless everyone else was doing the same thing.
France is, so far, in a less serious situation debt-wise, than countries such as Greece, Italy, Belgium and Portugal, where the debt to GDP rule will hit much harder.
Should competitive “internal devaluations” in the Eurozone squeeze inflation out of the system – which may be happening already – or lead to outright deflation with falling nominal GDP, the situation would go from bad to worse: the debt to GDP ratio would climb, and the one twentieth would rise as a share of GDP.
The debt ratio to GDP tool would not be a problem if the Eurozone were a fully fledged political, fiscal, monetary and banking union with a consolidated federal debt.
In this case the debt rule would have much the same effect as the balanced budget rule for US states. But the rule will not work as long as each member state is regarded as a sovereign state except in terms of monetary policy.
Austerity, however, is turning public opinion strongly against the “ever closer union of the European peoples” envisaged by the founding fathers of the European Union in the 1957 Rome Treaty, and thus the question becomes: will the monetary founder in face of popular discontent before a workable federal system can be implemented?