European Economic Policy: Co-ordination is vital
Today the Telegraph’s Ambrose Evans-Pritchard writes on the outcomes of the European summit. He notes of the austerity based solutions (and a permanent target of 0.5% of GDP structural deficits):
Personally, I am not a Keynesian – nor are many Daily Telegraph readers – but this strikes me as a mad commitment to make. For the Left it is surely an unmitigated disaster. They cannot pursue their economic agenda ever again. Fabians feared long ago that such an outcome was built into EMU. They called the euro a “bankers’ ramp”, but somehow their warnings were drowned out in the mass hysteria of monetary union.
As Owen Jones wrote last week in the New Statesman that the Treaty was a ‘disaster’ for the European left and Paul Mason noted that:
I can only add at this stage that, by enshrining in national and international law the need for balanced budgets and near-zero structural deficits, the eurozone has outlawed expansionary fiscal policy.
Because of this the FT’s Martin Wolf has branded the new ‘stability and growth union’ an ‘instability and stagnation union’.
I think though there is a wider issue here – the EU attempting to outlaw fiscal stimulus is a return to Dark Age economics but it is somewhat beside the point. Most of Europe as already engaged in austerity and results are clear to see – Citi is now forecasting a recession lasting 6 quarters in the Eurozone, something not even experienced by Japan in the 1990s. This has happened without a treaty change.
It is highly questionable that ‘fiscal stimulus in one country’ can succeed in the current environment in the Eurozone.
Bond market players may not react well to one country choosing stimulus over austerity and start to reduce their holdings of the stimulating country’s debt and driving up interest rates.
I think this is highly unlikely to be the case in the UK – our debt has a longer term maturity, there is a huge demand for gilts (hence the record low interest rates) and we have our own currency and central bank. The OBR, as Nicola has pointed out, certainly seems to believe there is room for a fiscal stimulus in the short term.
However for various Eurozone states the options are more constrained. It’s hard to envisage a situation in which, say, an Italian stimulus package wasn’t accompanied by a negative financial market reaction.
The real lesson of 2008-09 is that fiscal stimulus is most effective when done in conjunction with other countries – this provides less targets for the bond market and means no country is able to free ride of the stimulus of others. To return to the example above, an Italian stimulus in the context of a general European expansionary package would be far more likely to succeed. Even if the bond market reaction was muted such a stimulus might just suck in imports and fail to lift GDP.
The UK does have the fiscal room for a targeted, timely and temporary stimulus. It could help offset the collapse in domestic demand that has been the primary cause of our stagnation over the past year but such a stimulus would be even more effective if accompanied by similar macro-policies in Europe.
As the ETUI’s Andrew Watt has recently argued there are short term policy steps that could be taken now:
The euro area as a whole needs to be prevented from sliding into a renewed recession, which carries huge risks given already high unemployment and the strains on demand-side policy, and will make fiscal consolidation impossible. Avoiding this threat requires:
- An immediate cut in ECB interest rates to zero.
- The immediate provision of lender of last resort guarantees to euro area governments.
- Above and beyond that ECB commitment to delivering nominal GDP growth at least in line with trend (at least 5%) by means of unconventional monetary polices.
- Agreement on a fiscal stimulus package by countries with the fiscal room for manoeuvre together with a 12-month moratorium on additional austerity measures that reduce aggregate demand in deficit countries.
- Accelerated efforts by European authorities (EIB, Commission) to mobilise funding for infrastructure and other investment projects.
The policy makers meeting in Brussels last week were completely wrong to see austerity as a solution to Europe’s problems, but they were right that better European co-ordination of acro policies can be extremely useful. Of course, co-ordination of the wrong policies is doubly damaging.