Growing numbers of European countries are running large national budget deficits which their governments are finding increasingly difficult to cover through borrowing. According to the New York Times, “Euro zone governments have to repay more than 1.1 trillion euros, nearly $1.5 trillion, of long- and short-term debt in 2012, with about 519 billion euros, or $695 billion, of Italian, French and German debt maturing in the first half alone.” The Wall Street Journal provides the following national breakdown:
The danger is that some European governments will be unable to secure the funds required to pay their debts. Such defaults would threaten the financial stability of a number of large European banks, which are major holders of government bonds, and eventually the U.S. financial system because of the close ties between many large European and U.S. financial institutions.
At the Brussels meeting, government leaders agreed to raise some $270 billion and give it to the IMF which is supposed to use it provide loans to those governments in need, with its usual austerity conditions attached, of course. The leaders also agreed to speed up the introduction of a new European rescue fund that would do much the same. This determination to impose austerity on European workers stands in sharp contrast to another agreement. According to the New York Times, “The leaders sent an important signal to the bond markets by scrapping a pledge to make private investors absorb losses in any future bailout for a euro nation.”
The leaders rejected what would have been the most useful action—empowering the European Central Bank to directly buy government bonds, much like the Federal Reserve does for the U.S. government.
The leaders did approve two major long term policy initiatives. As the Wall Street Journal explains:
After a marathon session of negotiating that started Thursday and ran until early Friday morning, the leaders emerged with two principal achievements: Euro-zone members who run outsize government deficits will face automatic penalties, and all governments will put balanced-budget procedures of some form in their national laws.
Germany had wanted this limit on government borrowing made part of the EU constitution, thereby giving EU institutions the authority to enforce it. It was unsuccessful in achieving its goal only because of UK opposition; such major changes require unanimous approval on the part of all 27 member countries. As a result, the other 26 leaders have agreed to implement this “fiscal stability compact” by winning approval for it in each of their respective national parliaments.
This fiscal stability compact reflects the continuing belief of European political leaders that the current crisis was caused by runaway government debts and can only be contained through adoption of a balanced budget amendment. This is precisely the argument being made by conservatives in the United States. And it is just as wrong headed in Europe as it is in the United States.
Paul Mason, the economic editor of Newsday put it well, saying:
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. . . .
It has done what the US Republicans would like to do – and if you think about it, it has made what Gordon Brown did, and what Barack Obama (and indeed Wen Jia-bao) is doing illegal.
The result, if it works will be stability. It is hard to see how it promotes long-term growth.
Mason is probably overoptimistic that such a policy will even prove able to ensure stability. As for the claim that the current crisis is the result of out-of-control deficits, take a look at the chart below:
As you can see, Spain and Ireland, two of the countries with the biggest debt problems, were actually running strong surpluses before the crisis. On the other hand, Germany was in violation of the Euro zone agreement to keep yearly budget deficits below 3% of GDP from 2001 to 2005. Not surprisingly, once the crisis hit, almost every country was forced into running large deficits. Said differently, in almost all cases, large budget deficits are the result of the crisis not the cause.
In short, pushing austerity will produce a deeper economic downturn, resulting in bigger government deficits and a worsening debt problem. As the economist Kevin O’Rourke explains:
One lesson that the world has learned since the financial crisis of 2008 is that a contractionary fiscal policy means what it says: contraction. Since 2010, a Europe-wide experiment has conclusively falsified the idea that fiscal contractions are expansionary. August 2011 saw the largest monthly decrease in eurozone industrial production since September 2009, German exports fell sharply in October, and now-casting.comis predicting declines in eurozone GDP for late 2011 and early 2012. . . .
What is needed to save the eurozone in the medium term is a central bank mandated to target more than just inflation – for example, unemployment, financial stability, and the survival of the single currency. . . . This will require a minimal fiscal union; a full-scale fiscal union would be better still. Yet none of this was on the summit’s agenda.
Europe’s current approach to its crisis is crazy, and one can only hope that few if any national parliaments will endorse it. I suppose there is some reason to be optimistic. As the Wall Street Journal reports:
One particular complication is the bid to make sanctions automatic. It recycles an idea that the euro zone rejected in October 2010. At that time, the European Commission, the bloc’s executive arm, proposed that penalties for violating the fiscal rules be automatically imposed; unless the countries voted affirmatively to block them, they’d stand.
The longstanding rules work the other way around. Penalties are imposed only if countries vote for them. That led to the ignominious spectacle, in 2003, of France and Germany each breaking the deficit ceiling and each voting against condemning the other, killing enforcement efforts.
In the meantime, governments in Europe, much like in the United States, continue to defend the very economic structures and patterns of economic activity that led to the current economic mess while demanding that working people pay the costs. What a nightmare.