European policymakers look forward to the spring meetings of the International Monetary Fund and the World Bank for the cherry blossoms and warm sunshine that usually bless Washington in April. This year the Europeans provided a little warmth of their own: the first hints of a thaw in the region’s austerity policies.
Olli Rehn, the European Union’s commissioner for economic and monetary affairs, said he and his EU colleagues had received “plenty of advice” from IMF and U.S. officials about slowing deficit reduction and stimulating growth and jobs, but he insisted that those ideas were out of date. The 17 countries in the euro area will reduce their structural budget deficits by about 0.75 percent this year, half the pace of 2012’s 1.5 percentage point cut, Rehn said. By contrast, he noted, the U.S. is expected to reduce its structural deficit by some 1.75 percent thanks to the increase in payroll taxes at the start of the year and the automatic spending cuts known as the sequester.
Rehn’s boss, European Commission president José Manuel Barroso, underscored the softer budgetary stance in a Brussels speech just after the Washington meetings, saying the austerity agenda that has reigned in the EU since the bloc’s debt crisis erupted three years ago “has reached its limits.” And on April 26, the commission gave its blessing to a revised economic program by the government of Prime Minister Mariano Rajoy, which pushes back the target for Spain to bring its deficit below the euro area limit of 3 percent of GDP by two years, to 2016.
The new tone reflects changed circumstances. The aggregate deficit of the euro area is expected to drop to about 3 percent of GDP this year, down from 6 percent in 2011, lessening the urgency for further budget cuts. The promise of aggressive action by the European Central Bank has lessened fears of a breakup of the single currency and calmed governments’ worries about bond market vigilantes.
Officials are also increasingly sensitive to the economic pain in Europe: The euro area looks to be headed for a second straight year of recession in 2013, with the IMF last month forecasting that the region’s economy would contract by 0.3 percent. As part of its new economic program, the Rajoy’s government forecast that Spanish economic output would fall by 1.3 percent this year, similar to 2012’s 1.4 percent decline, and that unemployment would average 27.1 percent this year.
A new study of the EU-IMF bailouts in Greece, Ireland and Portugal, presented in Washington during the meetings, highlighted the austerity programs’ checkered record. Only Ireland has come close to regaining bond market access and improving its competitiveness, but growth has been slower than expected and unemployment — at 14.6 percent — much higher, the study found. Greece and Portugal have yet to emerge from recession or reduce their debt levels. The political sustainability of the programs “is still a question that remains open,” said Jean Pisani-Ferry, co-author of the study, conducted by Brussels think tank Bruegel.
The EU budgetary shift is more rhetorical than real. German Finance Minister Wolfgang Schäuble insisted that the bloc isn’t changing its fiscal policy. Spain’s new economic program consists of structural reforms such as increases in the retirement age and measures to foster the growth of small business rather than any fiscal pump priming. In fact, the government said it would have to postpone tax cuts that had been planned for 2014 just to meet its new 2016 deficit target.
Still, EU officials are promising other measures to strengthen the euro area. Rehn said the commission would issue proposals before the summer to complete a euro area banking union, including a resolution mechanism for winding up failed banks, a harmonization of deposit-insurance schemes and a provision for directly recapitalizing banks through the European Stability Mechanism.
