November 25, 2003
From the desk of Jane Galt:So long, stability
Europe's stability pact, which was intended to keep countries from running budget deficits greater than 3%, has been foundering for quite some time. Though initially aimed at profligate Italy, the actual culprits were Germany and France, which have been running big deficits over the last three years as their economies flirted with recession. Growth is still anaemic, and early this morning the finance ministers pulled the plug on the pact: France and Germany, they have agreed, will reduce their budget deficits when they damn well feel like it.
Does this put the future of the euro in jeopardy? Not yet. The biggest risk is that profligate governments will raise interest rates for everyone else by borrowing too much money. Since each government has less of an impact on interest rates than they did when they were borrowing in their very own currency, we could see a "tragedy of the commons" type situation where every government borrows too much, and the savings rate of the eurozone suffers. That might threaten the euro. It might just result in economic stagnation (though if you think France and Germany's deficits will produce this effect, you should also be worried about ours.) Or it might have a trivial effect. Though some economists (particularly those associated with the later years of the Clinton administration) like to claim marvelous -- nay, miraculous -- effects on interest rates from deficit reduction, the empirical evidence for the proposition that I've seen seems to be somewhat weak. Which means the bigger deficits might not raise interest rates that much at all. Or France and Germany could decide, for any number of reasons, to clean up their act and run in the black. So I wouldn't start writing any dirges for the Eurozone just yet.
Posted by Jane Galt at November 25, 2003 1:00 PM | TrackBack | Technorati inbound linksI think it is more likely to cause a big problem in implementing the French vision of the European Union. The lesson the smaller countries will learn from this is that France and Germany will feel free to bully them with 'rules' which will never be applied to the larger countries. The smaller countries are far less likely to trade in their current powers for a new system if they think the system will be even more stacked against them than it already is.
Your analysis is too complicated. Knowing that Europe is run by socialists is enough to understand what will happen to their economy.
If the purpose of the deficit controls were to help set the exchange rate (price) of the euro w/in the euro-zone, wouldn't the failure of two of the largest economies to stay in their zone affect the euro's ability to actually reflect its purchasing power?
To what extent is the purchasing power within Greece or Holland affected by the Franco-German action?
Large countries will bully small countries? No way. Thank God no one but France and Germany do that!
Large countries will bully small countries? No way. Thank God no one but France and Germany do that!
The point, any-nony-mouse, is that the small countries aren't likely to choose to give up what power they have in the circumstances.
On a larger point, anony-mouse:
Part of the core of the EU experiment/effort is that this is supposed to be a free association of states. Bullying was supposed to be passe, no longer part of the deal.
Certainly, at a minimum, the expectation was that ALL the members of EU would be subject to the same set of rules.
IF Germany and France are allowed to bully smaller states within the EU system, then the point of the EU experiment will have been lost.
I know part of the stability pact was enacted to keep the currencies from drifting out of alignment with each other, and with the Euro. But The Economist is surprisingly unhelpful in explaining what might happen; maybe no one is sure?
For example, I assume the French debt is still in francs? Is this true of new debt, too? Can the French still print francs to help cover their deficit? If so, I can see all sorts of problems; more money chasing the same goods means inflation, at least in France... tho I guess it would filter out to the rest of the EU as sellers move goods into France?
On cosideration, I'm guessing that new French debt is denominated in euros. So they'll suck in capital from all of Europe, and euro interest rates will rise slightly. Which may lead to an increase in saving to match, or more likely cut into private sector investment.
So I'm not clear on what disaster might follow, and what the mechanism is. Anyone?
I don't understand. Considering the fungibility of global capital, in what way is EU-style deficit spending by countries within a monetary union worse than US-style deficit spending by a country with its own currency?
The winning argument against the Euro in Britain has thus far been the inadequacy of a "one size fits all" interest rate. If governments are not running similar surpluses/deficits then this will further pull them away from each other. Ultimately if the eurozone economies don't converge then parts of the eurozone will be in recession whilst others are doing well. The result of this could well be civil unrest, pressure to leave the single currency, and even at the most extreme war.
Killing the stability pact as opposed to getting agreement to reform it will ultimately give governments permission to do what they please and follow the national interest. It's this that could do for the Euro in the end.
..."one size fits all" interest rate. If governments are not running similar surpluses/deficits then this will further pull them away from each other.
Okay, FreeDem, so the problem will be that countries with different deficits will not converge. I take it you mean that, if, say, Germany's budget is in balance, their economy will grow, while France's is in deficit and theirs will not? Would you mind describing the mechanism, tho? (Sorry, but I was lousy at macro.)
It seems to me that a similar problem would result from an EU country that ran a budget surplus while others didn't. (Or maybe an opposite problem.) Fortunately, surpluses are more talked of than seen...
Dean: Just FYI, I am not "any nony mouse," nor did I post that comment. (Admittedly this is hardly the most original pseudonym ever invented, so some confusion is inevitable.)
Three main problems here:
1) threatens weaker, less orthodox fiscal policy stance w/in eurozone meaning that the ECB will have to run tighter policy to avoid inflationary pressures from profligate spending. Growing indebtedness in Euros threatens the creditworthiness of all members.
2) With additional uncertainty over balance between fiscal and monetary stance w/in Eurozone, ECB will be less willing to support extension of Eurozone to new members (who begin to acceed next year). The 2007 joiners are likely to be put of until next decade.
3) France and Germany breaking the rules means it will be less likely to get others to keep to them: consider the fiscal positions of the next wave where Czech, Hungary and Poland are grappling with huge fiscal deficits - how can they be expected to adhere to Maastricht if FR and DE are not? Or assume that they do tighten belts to get in, will they then simply say "well now that we are in, let's do as France and Germany!"
It's over.
A question. Given how global capital moves around, is the idea of France and Germany "soaking up money" to cover their deficit anything to worry about when one compares just how much money the USA is going to have to "soak up" to cover its deficit?
On the other hand, I'm still not sure why we aren't seeing a global rise in rates given the size of the deficits coming down the line, so obviously I'm missing something...
I don't see why it should be such a problem per se if some EU countries have bigger deficits than others, what matters is the total debt of the countries involved. Some EU countries have no budget deficit, e.g. Belgium, but debt equal to 100% of GDP. Others have much lower debt, in some cases lower than the US. But even if some countries have more debt than others, they will pay the same price as would any leveraged company : pay a higher interest rate. Nobody argues that companies issuing junk bonds crowd out the market for triple A rated companies. And the argument that, unlike companies, sovereign states cannot go bankrupt is only technically correct : any state that would default on its debt would be unable to borrow on the markets for a long time and its politicians would have to operate in a very uncomfortable straitjacket (and lose the next election) because they have lost the ability to print money. The whole stability pact was silly and only a symbolic gesture at the time to convince sceptical Germans to give up their cherished D-marks.
What is less silly though is the way France and Germany have demonstrated that some pigs are more equal than others. But by doing so, they have effectively woken up all other EU members, except France's two satellites, Belgium and Luxembourg, that France and Germany hope to dominate the EU through new voting arrangements in the draft Constitution. Thanks God it happened now !
Some informations and facts :
1 : There is no more debt (either public or private) denominated in french franc or deutch mark : both disappeared in 1999 when euro was adopted.
2 : the stability pact limit the public deficit to 3 % of the GDP per year.
3 : The deficits of France and Germany are roughly 3.5 % of GNP. This has to be compared to the 6 % deficit of USA. It appears that USA are now entering into a new expansion cycle. And it appears too that german and french econmies are also recovering. This is the strongest argument against a strict and mindless compliance to the 3% deficit reference.
4 : today's exchange rate euro/USD is 1 euro = 1.19 USD while a year ago it was 1 euro = 0.95 USD. This shows that there is no link between France and Germany strictly abiding by the 3% deficit rule of the stability pact (which was the case a year ago) and euro strenght on forex markets.
As a consequence, from a strict technical point of view, there is no reason to stick to a rule (the 3% max deficit) that has been defined 10 years ago in totaly different circumstances.
5 : the stability pact is still valid, France and Germany confirm their support to the treaty, but there is now more room for some interpretation which just means that EU central bank has now the possibility to have a real economic policy... like mr Greenspan.
6 : Indeed as described in the convergence report (http://www.ecb.int/emi/pub/pdf/converg/english.pdf) the stability pact has already been applied with flexibility in 1997 and 1999 to allow all countries to qualify.
7 : about the treaty : position.http://www.ecb.int/pub/pdf/monetarypolicy2001.pdf
Some informations and facts :
1 : There is no more debt (either public or private) denominated in french franc or deutch mark : both disappeared in 1999 when euro was adopted.
2 : the stability pact limit the public deficit to 3 % of the GDP per year.
3 : The deficits of France and Germany are roughly 3.5 % of GDP. This has to be compared to the 6 % deficit of USA. It appears that USA are now entering into a new expansion cycle. And it appears too that german and french econmies are also recovering. This is the strongest argument against a strict and mindless compliance to the 3% deficit reference.
4 : today's exchange rate euro/USD is 1 euro = 1.19 USD while a year ago it was 1 euro = 0.95 USD. This shows that there is no link between France and Germany strictly abiding by the 3% deficit rule of the stability pact (which was the case a year ago) and euro strenght on forex markets.
As a consequence, from a strict technical point of view, there is no reason to stick to a rule (the 3% max deficit) that has been defined 10 years ago in totaly different circumstances.
5 : the stability pact is still valid, France and Germany confirm their support to the treaty, but there is now more room for some interpretation which just means that EU central bank has now the possibility to have a real economic policy... like mr Greenspan.
6 : Indeed as described in the convergence report (http://www.ecb.int/emi/pub/pdf/converg/english.pdf) the stability pact has already been applied with flexibility in 1997 and 1999 to allow all countries to qualify.
7 : about the treaty : position.http://www.ecb.int/pub/pdf/monetarypolicy2001.pdf
One thing is very clear - the French and Germans don't believe their own rules apply to them. So, what's new???
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