Budget Advice for the EU's Big Three
In a fresh sign of confidence about the euro zone’s recovery, the European Commission has just upgraded its growth forecasts for the bloc. This raises a question: Should governments now start tightening fiscal policy to put their public finances on a sounder footing?
It depends. Many euro-zone countries have worryingly high levels of public debt, and the best time to lower them is when economies are expanding. But they aren’t all in the same position. For some, such as Italy, tighter fiscal policy is essential. For others, such as France, it’s less urgent. And Germany is yet another case: Looser fiscal policy, with lower taxes and more public investment, would make most sense.
Italy’s choice is straightforward. Despite a modest upswing in growth, its public debt is still rising -- and projected to top 133 percent of gross domestic product this year. The European Central Bank is expected to cut its bond-buying program next year, so financing deficits may soon be more difficult. Italy needs to show investors it’s serious about budget discipline. This calls for a modest tightening of fiscal policy -- enough to put the debt on a credible downward path.
The case for fiscal expansion in Germany is less obvious. Output grew 0.6 percent in the first quarter, and the unemployment rate is just 4 percent. The budget is slightly in surplus, which has helped to bring government debt below 70 percent of GDP. What’s wrong with that?
The euro zone’s largest economy has a special role. Fiscal expansion in Germany would raise demand in other countries, helping their recoveries and strengthening Europe as a whole. In particular, a stronger expansion in the euro zone would let the ECB end quantitative easing sooner. Germany’s leaders have never liked QE; getting rid of it faster ought to suit them. One more thing: Germany has the largest current-account surplus in the world --and this surplus, in effect, gets invested abroad. Why not channel some of it back to Germany, through higher public investment?
France is in between. The government has persistently failed to get the budget deficit below the 3 percent allowed by Europe’s Stability and Growth Pact. Public debt is too high -- but bond yields have fallen since investors became convinced that Emmanuel Macron would be elected president, suggesting that investors are willing to give him and his reform agenda a chance.
There’s no imminent threat to stability, so Macron can afford to keep the fiscal stance unchanged for now. If the economy grows faster than expected, the deficit will fall faster, too, even with fiscal policy unchanged (under the influence of the automatic stabilizers).
The euro zone still needs a more integrated fiscal policy, with a common budget to help the bloc’s economy cope with the business cycle. For now, that isn’t happening. Until it does, the member states will have to plot their own fiscal paths through the recovery.
--Editors: Ferdinando Giugliano, Clive Crook
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