Since the attack on the World Trade Center, no U.S. official has been heard to worry about borrowing from America’s shrinking budget surplus. Priorities have shifted to rebuilding and shoring up the economy.
By Tom Buerkle
October 2001
Institutional Investor Magazine
That attitude is hardly matched in Europe, where fiscal discipline still reigns, despite growing calls to loosen government purse strings to stimulate growth. At a specially convened meeting in Brussels on September 21, European Union leaders reaffirmed their commitment “to respect the framework, rules and application in full of the Stability and Growth Pact’’ that requires governments to bring their budgets into balance in the medium term.
Although the EU policymakers allowed some room for automatic stabilizers to operate - such as welfare spending rising during a slowdown - they said deficit reduction remains a priority and that the European Central Bank should “play a central role’’ in restoring confidence.
At a concurrent meeting of EU finance ministers, only France’s Laurent Fabius proposed easing the Stability Pact rules. His proposal was easily overridden. Germany rushed to adopt a Dm3 billion ($1.4 billion) package of tax increases on cigarettes and insurance products to pay for new antiterrorism spending. The new taxes ought to keep the German budget intact, but they’ll also make it harder for the economy to grow.
Is that the right course?
To many U.S. economists, Europe’s dogged adherence to the Stability Pact is misguided. “In times of economic slowdown, there’s nothing wrong with accepting the reality of a changed fiscal position,’' says Wayne Angell, a former Federal Reserve Board governor who is now chief economist at Bear Stearns. “Trying to go the other way is a little Hooverian.’'
But to JÙrgen Stark, the Bundesbank vice president who helped write the pact when he was the No. 2 man in the German Finance Ministry, the rules remain as valid as ever. With 12 EU countries preparing to introduce euro notes and coins in January, governments must keep their budgetary promises, to assure their citizens the new money is sound, he says.
“This is now a credibility test for whether the Stability Pact works or not,” Stark says. “To ask for a change in the rules at the first difficulty is not a good signal to send.” He implies that fiscal discipline was a trade-off for monetary ease: The pact was, he says, “crucial in the policy considerations of the ECB.”
Stark insists that the original agreement is not a budgetary straitjacket and that it gives governments the leeway to address the slowdown. Eight of the 12 euro countries have budgets in balance or in surplus and can allow the stabilizers to work freely, taking no contractionary measures. In France, Germany, Italy and Portugal - all running sizable deficits - the governments should accept lower tax revenues and avoid new levies, says Stark, but offset increases in welfare spending with reductions in other spending. His prescription echoes German Finance Minister Hans Eichel’s suggestion that governments stick to spending targets rather than deficit targets.
“There is some flexibility in the Stability Pact,” Stark says. “This is to let the automatic stabilizers work. But to let them work in full, you have to have done your homework” - that is, deal with your deficit. Following Stark’s advice, however, may not prevent the German economy, which was veering close to recession even before September 11, from slipping further.
An alternative to adhering to deficit targets in the short term, suggests Deutsche Bank chief economist Norbert Walter, is to advance the tax cuts planned for 2003 and 2004. Politically, the country may feel the need to retain the Stability Pact, and a balanced budget is a worthy medium-term goal, says Walter, but getting the economy moving again is a more pressing requirement. “Do it in a smart way, but do it,” Walter says.
