European political leaders may be about to agree to a fiscal plan which, if implemented, could push Europe into a major depression. To understand why, it is useful to compare how European countries responded to downturns in demand before and after they adopted the euro.
Consider how France, for example, would have responded in the 1990’s to a substantial decline in demand for its exports. If there had been no government response, production and employment would have fallen. To prevent this, the Banque de France would have lowered interest rates. In addition, the fall in incomes would have automatically reduced tax revenue and increased various transfer payments. The government might have supplemented these “automatic stabilizers” with new spending or by lowering tax rates, further increasing the fiscal deficit.
In addition, the fall in export demand would have automatically caused the franc’s value to decline relative to other currencies, with lower interest rates producing a further decline. This combination of monetary, fiscal, and exchange rate changes would have stimulated production and employment, preventing a significant rise in unemployment.
However, when France adopted the euro, two of these channels of response were closed off. The franc could no longer depreciate relative to other eurozone currencies. The interest rate in France — and in all other eurozone countries — is now determined by the European Central Bank, based on demand conditions within the monetary union as a whole. So the only countercyclical policy available to France is fiscal: lower tax revenue and higher spending.
While that response implies a higher budget deficit, automatic fiscal stabilizers are particularly important now that the eurozone countries cannot use monetary policy to stabilize demand. Their lack of monetary tools, together with the absence of exchange rate adjustment, might also justify some discretionary cyclical tax cuts and spending increases.
Unfortunately, several eurozone countries allowed fiscal deficits to grow in good times, rather than only when demand was weak. In other words, these countries’ national debt grew because of “structural” as well as “cyclical” budget deficits.
Structural budget deficits were facilitated over the past decade by eurozone interest rates’ surprising lack of responsiveness to national differences in fiscal policy and debt levels. Because financial markets failed to recognize distinctions in risk among eurozone countries, interest rates on sovereign bonds did not reflect excessive borrowing. The single currency also meant that the exchange rate could not signal differences in fiscal profligacy.
Greece’s confession in 2010 that it had significantly understated its fiscal deficit was a wake-up call to the financial markets, causing interest rates on sovereign debt to rise substantially in several eurozone countries.
The EU’s summit in Brussels in early December was intended to prevent such debt accumulation in the future. The heads of member states’ governments agreed in principle to limit future fiscal deficits by seeking constitutional changes in their countries that would ensure balanced budgets. Specifically, they agreed to cap annual “structural” budget deficits at 0.5 percent of GDP, with penalties imposed on countries whose total fiscal deficits exceeded 3 percent of GDP — a limit that would include both structural and cyclical deficits, thus effectively limiting cyclical deficits to 3 percent of GDP.
Negotiators are now working out the details ahead of another meeting of EU government leaders at the end of this month that is supposed to produce specific language and rules for member states to adopt. An important part of the deficit agreement in December is that member states may run cyclical deficits that exceed 0.5 percent of GDP — an important tool for offsetting declines in demand: And it is unclear whether the penalties for total deficits that exceed 3 percent of GDP would be painful enough for countries to sacrifice greater countercyclical fiscal stimulus.
The most frightening recent development is a formal complaint by the European Central Bank that the proposed rules are not tough enough. Jorg Asmussen, a key member of the ECB’s executive board, wrote to the negotiators that countries should be allowed to exceed the 0.5 percent of GDP limit for deficits only in times of “natural catastrophes and serious emergency situations” outside the control of governments.
If this language were adopted, it would eliminate automatic cyclical fiscal adjustments, which could easily lead to a downward spiral of demand and a serious depression. If, for example, conditions in the rest of the world caused a decline in demand for French exports, output and employment in France would fall. That would reduce tax revenue and increase transfer payments, easily pushing the fiscal deficit over 0.5 percent of GDP.
If France must remove that cyclical deficit, it would have to raise taxes and cut spending. That would reduce demand even more, causing a further fall in revenue and a further increase in transfers — and thus a bigger fiscal deficit and calls for further fiscal tightening. It is not clear what would end this downward spiral of fiscal tightening and falling activity.
If implemented, this proposal could produce very high unemployment rates and no route to recovery — in short, a depression. In practice, the policy might be violated, just as the old Stability and Growth Pact was abandoned when France and Germany defied its rules and faced no penalties.
It would be much smarter to focus on the difference between cyclical and structural deficits, and to allow deficits that result from automatic stabilizers. The ECB should be the arbiter of that distinction, publishing estimates of cyclical and structural deficits. That analysis should also recognize the distinction between real (inflation-adjusted) deficits and the nominal deficit increase that would result if higher inflation caused sovereign borrowing costs to rise.
Italy, Spain, and France all have deficits that exceed 3 percent of GDP. However, these are not structural deficits, and financial markets would be better informed and reassured if the ECB indicated the size of the real structural deficits and showed that they are now declining. For investors, that is the essential feature of fiscal solvency.
Martin Feldstein, professor of Economics at Harvard University, was chairman of former US president Ronald Reagan’s Council of Economic Advisers and is former president of the National Bureau for Economic Research.
In the closing weeks of 2000, an army of Singaporean government officials descended on Washington to make good on a handshake between then-US President Bill Clinton and Singaporean Prime Minister Goh Chok Tong (吳作棟). They had agreed to strike an FTA after a round of golf in Brunei that past November. Running a small city-state, Singapore’s leaders and their diplomats live with their ear to the ground, attuned to the slightest geopolitical movements. They were motivated then by a big-picture strategic concern — keeping the US embedded in their region. An FTA they thought would help do that. It worked. Clinton’s successor,
On Oct. 7, the Chinese embassy in New Delhi sent letters to the Indian media asking them to refrain from calling Taiwan a country while reporting on its 109th National Day, which fell on Saturday last week. This move backfired and, on the contrary, contributed to the immense popularity of Taiwan among Indians, leading to an outpouring of congratulations for it on Twitter. Asked about the letter, the Indian Ministry of External Affairs said: “There is a free media that reports on issues as it sees fit.” Bharatiya Janata Party spokesman Tajinder Singh Bagga put up several banners outside the
On Oct. 6, the UN Committee on Human Rights released a statement on the concentration camps in China’s Xinjiang region in which at least 1 million Uighurs and other ethnic minorities are incarcerated. On the same day, Chinese President Xi Jinping (習近平) was telling delegates at a Chinese Communist Party (CCP) meeting that “happiness among the people in Xinjiang is on the rise.” It was a stark reminder of the CCP’s longstanding practice of trampling on human rights and deceiving the world. In October last year, the Taiwan East Turkestan Association and the Taiwan Friends of Tibet held an event titled
In a Facebook post on Wednesday last week, Chinese Nationalist Party (KMT) Taipei City Councilor Hsu Chiao-hsin (徐巧芯) wrote: “The KMT must fall for Taiwan to improve.’ Allow me to ask the question again: Is this really true?” It matters not how many times Hsu asks the question, my answer will always be the same: “Yes, the KMT must be toppled for Taiwan to improve.” In the lengthy Facebook post, titled “What were those born in the 1980s guilty of?” Hsu harked back to the idealistic aspirations of the 2014 Sunflower movement before heaping opprobrium on the Democratic Progressive Party’s (DPP)