The deceptive European fiscal policy

In 1981 the German Council of Economic Experts, in order to fight the recession, proposed a program of fiscal consolidation. According this “German view”, if fiscal consolidation is brought about through a cut in government expenditure, which is perceived to be persistent, this would signal a future reduction in taxes, meaning a higher disposable permanent income. This would boost consumption and therefore have an expansionary effect on aggregate demand and output. In that period the monetary policy in US and UK changed dramatically: Paul Volcker decided to fight inflationary expectations and very soon Lady Thatcher followed the some way. The rates of interest went up and the ratio between interest rates and growth rates was overthrown.

When the rate of interest is higher than the rate of growth the debt became a burden, and in order to stop the increase of the public debt is necessary to get a surplus of the primary deficit (that is the difference between revenues and expenditures (except interests).  In 1982 Denmark was the first country who cut the deficit, lowering public expenditures, but also rising taxes. In 1987 also Ireland followed the same path; in early nineties there were the experiences of the Scandinavian countries, in particular Finland. Since a good recovery of GDP followed the deficit cut, there are economists who think the German view was operating in those countries. Others think that i) they were all small countries,  ii) there were devaluation of the currency  and strong decrease of the rate of interest, so that these two factors may explain the result of a good increase of GDP.

Now that all European countries are cutting the deficit, can we expect an increase in private consumption and then in GDP? It would be wunderbar: the Euro area, that has now a surplus of saving over investments of one thousand billions dollars, would decrease the surplus, giving a net contribution to the world recovery. Unfortunately this perspective appears like an over-optimistic dream. It is more probable that things will go the other way around, with a long period of slowly growth and high unemployment.    

We could ask to ECB and to the German government if they would be happy if also the US would follow a restrictive fiscal policy; perhaps yes, or perhaps there would be fear of a slowing down of European (and in particular German) export. As Krugman says, J.C. Trichet’s statements are very similar to H. Hoover’s ones eighty years ago.

The uncertain future of the euro
The idea of arriving eventually at a unique money (and a unique market) was envisaged almost forty years ago (Werner Plan 1970). It is not necessary to stress the historical meaning of this achievement; it is more interesting the fact that there was a mutual gain among the countries members of euro: Germany obtained the complete stop of competitive devaluations of national currencies, and all the others – in particular the Mediterranean countries – obtained a lowering of interest rates on public debt (spreads were in fact reduced to few basic points). The Greek crisis widened the spreads of all European countries (even France) and accelerated German urge for a fight against public deficits.

German Weltanschauung links public deficit to inflation; financial operators are probably less certain of a causal relationship, but are now uncertain on the solvability of Greece, Portugal, Ireland, Spain, and also Italy, in descending order. European fiscal policy will slow down the economic recovery, so that the stop to the increase of public debt probably will shift onward. Of course if the European Commission (together with the Parliament) would be allowed to had a bigger role on public investments (along the lines dealt with by Delors Plan almost twenty years ago), we would have found a pull of domestic (at European level) demand, a part the export component.

Unfortunately there are very few possibilities of a hypothesis of a big plan of investments at European level; in this situation two possible scenarios can appear. The first is one in which troubles in the process of consolidation of Greek public debt determines a domino effect to others Mediterranean  countries, ending with a creation of a “strong” and more Nordic euro; the second in which a too long period of slow growth would give birth to political movement asking for a sorting out from euro, or as in the case of Italy, asking for a separation of Northern  regions from the rest of the country.