Editorial Board

Europe Should Rethink Austerity

European Union governments are starting to relax their austerity-first approach to economic policy. Better late than never; we’ve been advising them to do just that for months. It’s a shame the new thinking, however welcome, is too limited and incoherent.

Europe’s economy continues to deteriorate. Business and consumer confidence plunged by an unexpectedly large amount in April. The debts of the euro area’s most beleaguered economies are still rising despite all the belt-tightening.

Last week, Spain’s government said it would need two extra years to bring its budget deficit below the EU target of 3 percent of gross domestic product. The alternative would have been another round of tax increases and spending cuts, even as the unemployment rate, now 27 percent, continues to rise. Rather than bringing a rebuke from Brussels or Berlin, the announcement was calmly accepted. On the same day, German Finance Minister Wolfgang Schaeuble, the country’s leading austerity exponent, and Spanish Prime Minister Mariano Rajoy announced plans to develop a joint program for investment in Spanish companies.

Commenting on Spain’s fiscal target, Schaeuble said, “If the economy deteriorates, you don’t reinforce the economic downturn through deeper cuts.” Who knew?

Italy’s new government is discussing a plan to scrap a property tax on first homes, which proponents say would cost 8 billion euros ($10 billion) in forgone revenue. Not long ago, that would have drawn stern censure. France has announced that its deficit target will slip, too, and Schaeuble said Germany is open to permitting this.

Vicious Circle

“France’s labor costs are too high,” he said. “France is aware of that; that can’t be changed overnight, this must be done step by step and if that’s credible, one can be more flexible on the question of which deficits have to be achieved in which year.”

It’s a good thing that Europe seems ready to break the vicious circle of recession, higher debt, fiscal tightening and further recession. Still, refraining from what Schaeuble calls “reinforcing the downturn” through deeper cuts is only a start. A coordinated fiscal relaxation across the euro area is also needed, led by Germany and the other stronger economies. Also indispensable are further measures to control the danger -- not to be discounted -- that too much fiscal easing in debt-stressed countries such as Spain and Italy will renew last year’s market turmoil.

This week, Italy’s government sold long-term bonds at a yield of just under 4 percent, the lowest since Europe’s debt crisis escalated in 2010. For this, thank the commitment the European Central Bank made last year under its new president, Mario Draghi, to do “whatever it takes” to hold the euro system together. But rates this low shouldn’t be taken for granted. The markets have panicked before, and they’re capable of panicking again. Remember that many euro-area economies still have unsustainable debt trajectories.

The ECB’s calming promise therefore needs bolstering, not with self-defeating commitments to severe austerity in crippled economies, but with fiscal burden-sharing, monetary stimulus and real progress on structural economic reforms. (Spain’s unemployment is high not just because demand has been crushed but also because its labor market is broken.)

The ECB has an early opportunity to remind markets that it means to keep its promise: It should cut its benchmark interest rate when its policy council meets this week.

Monetary policy, however, can only do so much, and Europe’s weakest economies can’t safely ease fiscal policy as much as their plight requires without the support of Europe’s strongest economies.

Slipping Targets

Support must entail more than allowing fiscal targets to slip. Europe began a discussion in 2011 and 2012 about collective fiscal policy and fiscal burden-sharing. It made little progress before Germany’s impending election snuffed it out. That conversation urgently needs to be revived.

For the moment, the EU has taken a proposal for a common resolution fund for distressed banks -- the fiscal component of its promised banking union -- off the table to assuage Germany’s electoral sensitivities. That plan is needed to guard against a sudden further setback in Europe’s prospects and to put the euro area finally back on the path to growth. Europe still has a lot of rethinking to do.