Mody, A. (2014) “Are the Eurozone’s fiscal rules dying? – if so: good riddance“, Bruegel Institute, 28 October.
The European Commission and European Council have blinked. Reprimanding France and Italy for their transgressions of the fiscal rules was too risky. With face-saving measures, France and Italy will now break the eurozone’s prized fiscal rules.
While unseemly in the eurozone context, this is a good economic outcome. Forcing deeper austerity upon fragile economies is destructive. Yes, sure, the French and the Italians could have better managed the balance between taxes and spending. But fine-tuning those through a collective process is absurd.
Despite the small victory for economic good sense, it is too early to cheer. Indeed, the eventual agreement with France and Italy may well entail excessive austerity: we have no good way of knowing because the discussion has been focused on numerical targets rather than on economic considerations. Regrettably, the economic mythology of austerity lives on.
When Hans-Werner Sinn asserts that the reduced austerity is a license to run up fresh debts, he speaks for many who insistently disregard the empirical evidence. The evidence is overwhelmingly clear. Single-minded austerity caused growth to stall; as a consequence, the debt/GDP ratios increased rapidly, leading to the onset of a cycle of rising debt and deflation in the most distressed member states (Mazzolini and Mody, 2014). But no matter, the instinct remains that the rules must be respected.
The reason to be cautiously optimistic is that the French and Italian revolt may encourage new challenges from other countries. Such a momentum would politically discredit the rules, leaving them to atrophy. True, such optimism is premature. Germany and France did flout the rules in 2003, undermining their credibility. But instead of withering away, the rules reasserted their grip at precisely the wrong moment, when—amidst the crisis—the distressed economies needed the oxygen of fiscal stimulus.
Relevant posts:
- Wolff, B. G. (2014) “Europe’s fiscal wormhole – with all of the rules pointing toward recession, how can Europe boost recovery?“, Project Syndicate, 24 October.
- Wolff, B. G. (2014) “Europe needs new investment, not new rules – the EU must avoid another useless fight over its fiscal rules and instead use political capital to foster growth“, Bruegel Institute, 25 June.
- Micossi, S. (2014) “Bail-in rules in EU banking union and financial stability“, VoxEU Organisation, 05 June.