The euro was introduced in 1999 by 18 European Union countries. Sharing the same currency supposedly obligates the countries to look to their fiscal and economic policies as a matter of common concern and to coordinate those policies with the other members. This coordination follows special treaties and rules such as the Stability and Growth Pact, which aims ensuring the sustainability of public finances and economic stability, stating that deficit must not exceed 3% of gross domestic product (GDP) and public debt must not exceed 60% (of GDP). Many Eurozone countries flouted the rules during that preceded the crisis, for example Germany flouted the rules in four years since 2003.
The crisis hit the Eurozone in 2008 and the need for coordination of policies became more important than never. During the first couple years of crisis the order was to spend. The countries of the south followed this but certain countries of the north took this opportunity to follow austerity policies and balance their budgets. Part of this can be seen in the graphic below:
Fig. 1 (Government debt as a proportion of GDP, source BBC)
These efforts – of northern countries – to equilibrate their deficits generated doubt in the sustainability of the sovereign debt of southern countries. As consequence the latter saw their sovereign interest rates increase significantly, creating strong constraints of government financing and leading some countries to ask for bailout as they were unable to borrow in the financial markets, for example Portugal, suffering from a situation of sudden stop in capital flows.
The solution found by the European Commission, International Monetary Fund (IMF) and European Central Bank (ECB) – known in Portugal as troika – to solve this problem was to replicate and enforce economic policies adopted and supported by the north countries, known as austerity policies (avoiding expansionary fiscal policy for fight a crisis).
Some countries from the north, and especially Germany, believe that austerity is the recipe for the crisis, and wants southern member states to significantly decrease deficits and run current account surpluses, even if it creates more immediate poverty, unemployment and social convulsions. What one must see is that current account surpluses have to be “compensated” by other countries’ current account deficits, and neither Germany – nor other countries which felt smaller impact of crisis – are willing to abdicate the strategy of balanced accounts to run current deficits directed at boosting more fragile countries’ economies. This implies that the south countries don’t have another way unless bet on export-led growth, which many think unreasonable being the Eurozone so large. Even in that case, if all countries were to run current account surpluses, the euro would appreciate, and offset at least part of the effect.
This persistent idea of too much austerity in each country at the same time – that some call obsession – may very well be a self-destructive behavior. European Union (especially Eurozone) should stop and think about what are the foundations and original values that created the monetary union: commitment, solidarity and coordination. This coordination shouldn’t be about countries with better performances and stronger economies trying to impose policies on other countries for their own benefit.
Germany growth has just stumbled, the euro area is on the verge of finding itself in recession once again, and deflation (a state where many countries are) in the euro area as an aggregate is a close and dangerous scenario, given that the zone’s overall inflation rate decreased recently to 0,3%. It is also true that needed structural reforms have been avoided, and dodged, but one cannot interpret austerity as structural reforms, reality has proven that these are rarely the same. This has also to do with the targets set by Sustainability and Growth Pact, which ‘impose’ pressure to avulse results instead of giving incentives to promote growth and reforms when needed.
Countries in the southern Europe suffer from lack of aggregate demand, and if sovereign debt crisis imposes efforts in austerity policies, that lack of economic performance could be offset by expansionary macroeconomic policies of other (northern) countries. Fiscal cuts should not be imposed if not at the right pace for each country, avoiding sharp and deep negative effects on the economy; Reforms must take place but not in form of simple cuts or taxation in order to meet the agreed targets.
In conclusion, the biggest economic problem in the euro area is the problem of coordination failure due to fiscal policy controversies among the member states. The key solution is a higher degree of commitment to the foundations of the monetary union and therefore a more serious coordination, which takes into account that countries are expected to act as a hole and not individually. Coordination is not about all countries applying the same recipe, but about each country contributing with their share for the common solution.
We would like to remember that: “If Germany wants peripheral countries to become more like Germany, Germans may need to become more like southern Europeans” (5th Nov, UGO PANIZZA, The Economist)
Fig 2. Oct 25th, 2014, The Economist (Cover Print Edition)
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