Today the Irish people will vote on the Treaty “on the Stability, Coordination and Governance in the EMU”, also known as the “fiscal compact”. This referendum is of paramount importance for the whole European Union. I recently wrote an editorial on the French daily Le Monde, together with Imola Streho, explaining why we believe it to be poorly designed and economically ill conceived. Here is an English version.
I am preparing a class on the crisis, and for the first time I have put together in a single place the actual numbers that I discussed sparsely in the past. Taken all together, they are even scarier. So scary, that I want to share them.
Paul Krugman has an interesting piece on federal and local expenditure in the United States, where he shows that the consolidated fiscal stance has been considerably more restrictive with Obama than during the Reagan era. This is not what retained my attention, nevertheless. Krugman does not mention that most of the US states (the exception being Vermont) have some form of balanced budget amendment. Krugman himself had warned a while ago that this made the task of the federal government in fighting the recession particularly hard. But once again, this is not the point I want to make.
I recently wrote a paper with Jerome Creel and Paul Hubert, in which we try to assess the impact of the different fiscal rules that are being discussed for reforming the Eurozone governance. For our simulations we took into account the standard Keynesian positive effects of deficit spending: Government expenditure substitutes missing private demand, and hence supports economic activity. But we also embedded a negative effect of deficit and debt, that goes through increased interest rates (the famous spreads). High interest rates make it harder for the private sector to finance spending, and hence depress aggregate demand and growth. We assessed the performance of the rules in terms of average growth over the next 20 years.
The European Council meeting, next Monday, should finally lift the veil of mystery that has surrounded the new “fiscal compact”, the set of rules supposed to govern fiscal policy in EU member countries. As of now, the only official document in our hands is the Statement approved by the Heads of State and Government at the December 9 meeting.
I have argued at length that I am not in the camp of those who believe fiscal profligacy is the source of EMU problems (recently, here and here). Rather the contrary, I always thought (see for example here and here) that even the current rules de facto prevented EMU countries from effectively using the standard tools of macroeconomic policy.