EU Fiscal Stimulus Is Just a Rule Change Away
The European Central Bank is expected to extend its quantitative easing program further during the meeting of its governing council this week. The irony is that while the ECB has various options for continuing a program that isn't working, national governments have relatively few options for embarking on one that most agree is sorely needed. As Mario Draghi and others have said on multiple occasions, the ECB cannot deliver on its own. It needs governments to use fiscal levers to help stimulate spending and growth.
What prevents European governments from doing that right now is ostensibly the Maastricht deficit and debt limits (3 percent and 60 percent of gross domestic product respectively). While the European Commission has said that it would not count some investment spending in those limits, the rules are unclear and make it difficult for countries in breach to invest. What is needed is a change that brings national accounting more in line with reality and the sound principles used in the private sector.
Infrastructure investment in Europe is currently counted as an expense that gets added to (already bloated) national budgets. That fails to account for any multiplier effect the measures might have or the increase in productivity that is unleashed when, say, digital infrastructure is expanded or new transport links are created.
An investment, rather, should be amortized over the period it will be used for, just as it is in the private sector. A company that invests in new machinery, for example, amortizes it over many years. The same could even be true for R&D spending, which can deliver many gains in a knowledge economy.
The debt level argument against fiscal stimulus suffers from a similar flaw. The 60 percent of GDP debt limit was established because under normal growth, inflation and interest levels, it was considered a tipping point, beyond which debt could snowball. That logic makes little sense in a deflationary environment in which a number of euro zone countries have negative interest rates, mechanically decreasing the debt. It also ignores the long-term growth-producing benefits of the investment.
An accounting convention also means that central bank holdings of government debt are counted as part of the total debt-to-GDP ratio. In the private sector, a company typically consolidates its assets and liabilities across various wholly owned subsidiaries. Why not governments? Officially the average debt-to-GDP level in the euro zone is 92 percent. But deduct government debt owned by the central bank (leaving so-called net debt), and any fungible assets such as investment grade corporate bonds, and a different picture emerges.
As of June of this year, such assets in the euro system represented about 2.2 trillion euros (over 20 percent of GDP), projected to rise to about 3 trillion euros by the first quarter of 2017. Thus the "consolidated" debt-to-GDP of the euro zone would be close to 60 percent of GDP in the coming months. In other words, netting the asset gains made through the QE programs put the euro zone within the Maastricht limits, leaving it room to invest.
Over time, investment from previous years would need to be accounted for so changing the rules would make little difference given a relatively constant level of investment. However, for a few years it could greatly stimulate investment and it would encourage investment during a recession, giving governments a countercyclical tool.
In June, Belgian Finance Minister Johan Van Overtveldt gave a presentation to his fellow euro group finance ministers suggesting an amortization rule for investment, which he says was positively received. Philippe Maystadt, the former head of the European Investment Bank, has also called for a change in the accounting of investments by Eurostat and the European Commission. The issue is due to be on the agenda as EU finance chiefs and central bankers meet in Bratislava Sept. 9 and 10.
Changing the rules doesn't change the reality of years of government misspending. It doesn't change the fact that the Maastricht criteria were a political construct of a particular time. If they cannot be reformed, then in true EU fashion they can be fudged. The EU has been nothing if not creative with its rules in the past; there can be little doubt that it could find a way if the will exists now.
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Jean-Michel Paul at JPaul@acheroncapital.com
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