July 15, 2003


I do not, repeat do not, understand the thinking of western Europe's economic policy makers:

Morgan Stanley: Finance ministers of the 12 EMU countries gathered yesterday for their regular meeting, the first under the Italian presidency of the Council. EMU-outs will meet today in the ECOFIN meeting.  While recognizing the difficult juncture for the economy, the assemblage reiterated the usual rhetoric, supportive of the Stability Pact and the process of fiscal consolidation.

The EU Commission released a briefing note ahead of the Eurogroup meeting.  The Commission said that growth in the euro area this year would be 0.7%, lower than its original forecast and more consistent with the 0-0.4% range that its indicator-based model suggests for Q2 and Q3. Weak growth will put budgets under pressure and lead to further slippage. "The weak economic outlook poses a risk to the budgetary targets set in the last round of stability programs, despite the fact that all member states remain committed to fiscal consolidation", says the report.

EU Commissioner Solbes reiterated that the Stability Pact does not need to be modified, and the same message emerged from other several comments.  French Minister Francis Mer said that Europe should try to restore growth "within the spirit of the Pact".  Comments from German, Dutch, Belgian, and Austrian authorities were even more inclined to austerity. "We stick to the rules and play the game according to the rules" said the Dutch representative, while the Austrian representative stressed that "there should not even be a discussion as the Stability Pact is one of the cornerstones of EMU"...

On this side of the Atlantic Ocean, the idea that one took active steps to raise taxes and cut spending to try to move budgets closer to balance in recessions (rather than letting fiscal automatic stabilizers work, or even reinforcing them) has been dead for almost seventy years. The fact that it is alive and well in western Europe is very strange indeed.

Posted by DeLong at July 15, 2003 05:17 PM | TrackBack


The single-currency regime was driven primarily by poltiics rather than economics from the beginning. It still is.

Posted by: Jim Glass on July 15, 2003 05:24 PM

Here's an answer - say one thing and do another. A senior member of Chancellor Schroeder's SPD has said that borrowing more to bring a tax cut planned for 2005 forward to 2004 is acceptable. Austria's PM outted French plans to maintain the spirit, but not the letter, of the Stability Pact in 2004. The little Eurozone countries are irritated as hell, since they were bludgeoned into meeting Stability Pact guidelines on the way in, but that isn't going to change things. Besides, the Stability Pact is stupid. EC President Prodi said so.

Posted by: K Harris on July 16, 2003 07:35 AM

Well see if they keep saying this once Germany slides into deflation.

Posted by: Lorenzo on July 16, 2003 07:35 AM

It's really very simple, Brad.

The view in Europe I understand is that Europe's economic problems are mainly structural, not cyclical. The European Central Bank has been asking European national governments to reform their labour markets to boost employment and to make other supply-side improvements. The Bank of Japan has been doing the same, to avoid blame for its own incompetence for the last ten years.

You and I both know that a) these are long term measures, while the unemployment problems are immediate and b) in any case, there's not the slightest chance of the French or Germans forgoing generous welfare payments and employment protection.

In any case, the Brits, Danes and Swedes would be very wise to stay as far as possible from the Euro for decades to come.

Posted by: PJ on July 16, 2003 07:46 AM

Brad: Beyond the observation that their behavior is strange, are you aware of any thoughtful explanations (intellectual, institutional, values, economic historical nightmares, or whatever)of why the European central bankers are doing to which you can refer your readers? Presumably they are not stupid and have training that at least partly overlaps that of mainstream U.S. and U.K. economic thought.

Jim Glass's point that the Euro is a political project seems like a major part of the story. However, presumably the European central bankers would like to achieve their political objectives and have reasonably good monetary policy too, if they can. (But see, Bush fiscal policy. ;-) ) Jim: do you think that there are specific Euro-related political objectives that are inherently inconsistant with at least a somewhat growth-oriented monetary policy? If so what?

Or, do the coordination, etc. problems of getting the Euro to work at all make it too hard to simultaneously implement what we in the U.S. see as the normal anti-business cycle functions of monetary policy. If they exist, are these problems inherent in European monetary unification, or is there the possibility of a learning curve for the central bankers, as there has been for the Federal Reserve Board (hopefully on a shorter time frame than 1914 to Volcker-Greenspan).

Posted by: Martin on July 16, 2003 07:48 AM

The Dutch economics minster, Gerrit Zalm, is a hard-line supporter of the thinking behind the stability pact. He's been minister in the last three Dutch administrations, and he is a firm believer in the adage "when times are good, spend; when times are bad, save", much to the chagrin of Dutch economists who feel the Dutch economy is badly in need of a stimulus in order to kickstart local demand.

However, some Dutch commentators (e.g. Gerbert van Loenen, writing in the daily "Trouw") feel that there is a certain logic to Zalm's behaviour: the idea is that by hammering through salary freezes and lowering public spending, the Netherlands will improve its competivity and lower its national debt, and be well prepared to ride the coattails of pan-European growth when its larger neighbours France and Germany resort to profligate public spending and thus stimulate general European demand.

Having survived the recession with public finances largely intact, and businesses lean and mean, and enjoying the demand generated by other governments that have subsequently put themselves in deeper debt, Dutch politicians can then engage in the sanctimonious finger-wagging they are generally so fond of.

Posted by: Elliott Oti on July 16, 2003 10:02 AM

In the same vein, I suspect, most of the other supporters of the stability pact are hoping for roughly the same thing, albeit on a somewhat larger scale: they want to get leaner and meaner, and keep deficits on a leash, all the while hoping that other countries (read the US, South-East Asia, maybe China) work hard at getting global demand back up and running.

Remember, unpleasant as unemployment may be, as far as being unemployed goes Europeans generally have a much higher pain threshold than Americans in general, due I think to their better (YMMV) social security safety nets and also due to the fact that they have more first-hand experience of unemployment in past decades. The urgency I see in Anglosphere economists vis-a-vis the danger of deflation is simply not present to the same degree in Europe.

Posted by: Elliott Oti on July 16, 2003 10:13 AM

Without meaning to monopolise your comments section, I would also like to point out that far too many non-EU commentators regard the EU as a unified bloc, whose member states have a generally European outlook. This is not the case: EU solidarity is IMHO somewhat less than that within a confederation, and member states are quite prepared to screw the general EU interest in favour of their own special interests, and this goes for each and every single member. Free-riding is a much bigger problem within the current framework of the EU than it is within, say, the US, where each state acknowledges, and is beholden to, the federal interest.

Posted by: Elliott Oti on July 16, 2003 10:25 AM

These respectable economists say that the constraint that the SGP imposes on fiscal policy has been overstated.

Fiscal Policy and Monetary Integration in Europe
Jordi Gali, Roberto Perotti


A popular view among economists, policymakers, and the media, is that the Maastricht Treaty and then Stability and Growth Pact have significantly impaired the ability of EU governments to conduct a stabilizing fiscal policy and to provide an adequate level of public infrastructure. In this paper, we investigate this view by estimating fiscal rules for the discretionary budget deficit over the period 1980-2002, using data on EMU countries and control groups of non-EMU EU countries and other non-EU OECD countries. We do not find much support for this view. In fact, we find that discretionary fiscal policy in EMU countries has become more countercyclical over time, following what appears to be a trend that affects other industrialized countries as well. Similarly, we find that the decline in public investment experienced over the last decade by EMU countries is part of a world-wide trend that started well before the Maastricht Treaty was signed.

Posted by: P O'Neill on July 16, 2003 11:23 AM

Well, the idea of raising taxes and cutting spending to balance budgets in recessions may be dead at the federal level, over here, but it is alive and well at the state level.

Posted by: rvman on July 16, 2003 12:36 PM

>>The single-currency regime was driven primarily by poltiics rather than economics from the beginning. It still is.

Not so. It was always a way for the French, Italians and Spanish to buy German monetary credibility, and it has worked fantastically for them.

Posted by: dsquared on July 16, 2003 12:36 PM

Well, the idea of raising taxes and cutting spending to balance budgets in recessions may be dead at the federal level, over here, but it is alive and well at the state level.

Posted by: rvman on July 16, 2003 12:37 PM

Much like the NBER assessment of the Maastrict Treaty's effect on fiscal policy, Bank of America's European economist, Lorenzo Codogno, argues that the ECB is doing a pretty good job in easing monetary policy. He sees considerable flexibility in the fact that the ECB has cut rates 2.75% since May 2001, even as inflation was running above target. Taking it a step further, John Lipsky at Morgan applies a bit of Taylor Rule to compare Fed and ECB policy actions, finding that the ECB has actually been more aggressive than the Fed. The ECB has kept rates about 1% lower than the Taylor Rule would prescribe, while the Fed has mostly kept rates tighter than the Taylor Rule would prescribe, and has moved at a lag to the Taylor Rule target. The trick is a bigger output gap and lower inflation in the US than in the Eurozone, which in a Taylor Rule world means lower nominal rates are appropriate.

I'm agnostic for now, but I find it interesting after all the howling about how bone-headed the ECB has been that it is possible to make a reasonable argument in the other direction. Those who see risks overwhelmingly in the direction of recession have every reason to argue that the ECB has more room, in nominal rate terms, to ease than either the Fed or the BoJ, but ECB officials report that they do not see overwhelming risks of deflation.

Posted by: K Harris on July 16, 2003 12:50 PM


States of the U.S. have to raise taxes and cut spending because they are required by their constitutions to have balanced budgets. Do you have a better idea of how to achieve that in these times? Do you really want the states to have the liability of debt from year to year?

Posted by: James S. W. on July 17, 2003 01:56 PM

Elliott Oti's point is right - the participants are each running their own, not an EU, agenda. But the more they seek to screw the others, the more they must pretend to be vraiment communitaire.

In this context, note the line from the French about restoring growth "within the spirit of the Pact". When a politician refers to keeping the spirit of a pact it usually means that they want to flaunt its letter. But they're right - given the extreme tardiness of the ECB in seeing the danger, such a flaunting is now the only hope for restoring growth.

Posted by: derrida derider on July 18, 2003 06:14 AM
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