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Is the Stability
and Growth Pact anti-growth? by Giorgos Karanasios* and André Azevedo
Alves** The euro
area's Stability and Growth Pact has been under growing pressure from both
European politicians and opinion-makers who maintain that the limitations
imposed on budget deficits make it impossible for governments to pursue so
called "expansionist" fiscal policies that would allegedly be
appropriate for the current economic downturn. As the
pressure increases and several euro area governments (including the influential
French and German executives) lobby more or less explicitly for a
"relaxation" of the commitments to limit and progressively reduce
budget deficits, it is now more relevant than ever to understand the
rationale behind the constraints currently imposed by the Pact. The
Stability and Growth Pact sets a limit of three percent of GDP to deficits
and also demands that euro area governments bring their budgets into balance
in the medium turn. As stupid
as it may seem to some high level EU officials, the fact is that strict,
precise and rigorous limitations on deficits are one of the essential
conditions that must be satisfied in order for the euro to be a stable and
credible currency. In the current monetary system, recurring budget deficits
would indicate to the financial markets that the euro has significant
depreciation and inflationary risks. The perception of those risks would have
adverse effects on investment, therefore damaging the prospects for economic
growth and job creation in the euro area. The
limitation of deficits, combined with continuing fiscal competition between
the several member states' tax systems, is one of the few existing safeguards
against excessive government spending and the crowding out of private
investment in the euro area. The
proposals for discretionary fiscal loosening will result, if implemented, in
more governmental bond issuances. Given the fact that the borrowed money will
be mainly spent on wage and pension increases (therefore boosting
consumption), and on public works, that typically have declining returns and
a significant level of waste, it is highly unlikely that any real and lasting
growth could ever result from such a process. Instead, savings will be eroded
and a new vicious cycle of inflation and growing public debt will be set in
motion, once again repeating what happened in the recent past. A sad and
heavy legacy will be left for future generations that will be forced to bear
the burden of more taxes, either directly or through monetary depreciation.
Only limited deficits can limit the growth of public debt and are in line
with the general common sense equation that governments (and people) cannot
live beyond their means. Further
relaxation of the deficit ceiling would strongly undermine the ECB’s monetary
policy and is in conflict with its main anti-inflation policy goal. An
increased supply of government bonds generates upward pressure on interest
rates and boosts inflationary prospects. Thus, monetary stability would be
endangered and that would disrupt the credibility and reliability of the Euro
exchange rates and the quality of the long term economic calculation
essential for productive investment. Insisting
on sizeable spending programs ignores the other policy alternatives and is a
convenient way to avoid serious and much needed reforms. It also means a lack
of trust on the entrepreneurial and spontaneous order of free markets and a
return to state interventionism. Furthermore, who can ensure that
expansionary fiscal policies will not be abused, mainly in pre-electoral
periods? No one can exclude the existence of hidden motives on the part of
EU’s government agents, mainly those who are the most vocal in their
criticisms of the existing Pact. Those in greater need of maintaining their
political power through paternalistic behavior towards their voters and
through the distribution of benefits to special interest groups would
naturally not mind loosening and breaking the rules. That is obviously the
case both in If there
is further relaxation of the limitations on deficit spending or if exceptions
are allowed for some member states, all euro area governments will be
increasingly pressured by interest groups in their countries to also increase
deficit spending, therefore generating a vicious circle, which would
undermine both the euro and the prospects for economic growth. The
fundamental point is that eliminating deficit spending is a pro-growth
economic policy and would be desirable even if the Stability and Growth Pact
did not require it. In order to tackle the current economic downturn there
are plenty of things that governments can do instead of being obsessed with
the destruction of the Stability and Growth Pact. If euro
area governments are truly interested in stimulating growth and employment
they should greatly reduce public spending, cut taxes, allow greater
flexibility in labor markets, drastically reduce bureaucracy and liberalize
over regulated markets. Increased public spending and budget deficits are
part of the problem, not of the solution. April
2003 * Giorgos Karanasios – Greek Libertynet for the promotion of
Classical Liberalism ** André Azevedo Alves – Causa
Liberal - Portuguese association for the study and debate of Classical Liberalism |