Of perception gaps and financing traps

April 26, 2013

The current public debate on fiscal policy is often portrayed as a political battle between the Austerians and Spendanigans. As a doctrinaire agnostic, I refuse to take an oath to either of these, as there is no silver bullet or single issue movement that can solve the present crisis and return Europe to a sustained recovery. Besides, to focus only on fiscal policy misses the point that both pursuing structural reforms and easing credit conditions are at least as important in order to lubricate the economic engine and make it run with its full growth potential.

Reading the media coverage of recent days, one gets the impression that there is a fundamental shift underway in the Commission’s economic policy. This perception gap is down to a pervasive and persistent view that the Commission’s economic policy consists of a rigid insistence on fiscal consolidation and little more. But in reality, we have insisted that structural reforms to enhance sustainable growth and job creation are at least as important as a sound fiscal policy. And Europe is making headway in this regard. Most European countries have enacted major structural reforms, especially of labour and product markets, in recent years. 

So the EU’s economic policy aims at promoting sustainable economic growth and job creation and containing the increase in debt. To achieve these twin goals, which go hand in hand and complement each other, we encourage the balancing of public finances through a consistent fiscal policy by reducing structural deficits over the medium term.

In line with this policy, the pace of fiscal consolidation is in fact now slowing down in Europe. This year, the structural fiscal effort will be around three-quarters of a percentage point of GDP in the euro area – half of last year’s figure of around one-and-a-half percentage points. The decisions leading to this reduction were made in 2012, in line with the Commission’s recommendations of last spring. By comparison, the United States is reducing its deficit by around 1.75 percentage points this year, proportionally twice as much as in Europe.

This slowing down of the pace of fiscal consolidation in the EU has been made possible by three factors: first, by the increased credibility of fiscal policy which the euro area member states have achieved since 2011; second, by the decisive action the ECB has taken to stabilise the markets; and third, by the reform of EU economic governance, which provides an effective framework for a differentiated fiscal adjustment and the advancement of structural reforms.

Thanks to these factors, we have the room to make fiscal policy with a more medium-term perspective. This was not possible in 2010-2011, when several euro area countries were in danger of becoming insolvent or in a free fall to the whirlpool of prohibitively high interest rates. At that time, many member states had to restore their policy credibility by difficult decisions to bring their public finances onto a sustainable path.

In this context, a word on the current discussion over the Reinhart-Rogoff research into the correlation between debt and growth. The Commission’s economic policy recommendations are not based on any single piece of research. We design our policies on the basis of a broad-based assessment, drawing on a wealth of studies – and also of course on our own analyses.

The precise causal relationship between debt levels and growth is a complex one. There is no hard-and-fast rule; it is affected also by many country-specific factors. 

One example: the US has the advantage of an international reserve currency that gives it much greater debt tolerance than a small eurozone country which confronts market discipline early on. 

Another example: the low or negative growth seen in Ireland or Spain is not the result of high public debt. Rather, both the low growth and the high debt are the outcome of financial and banking crises which followed an unsustainable accumulation of private debt. But however it arose, high public debt may well still have an impact on growth in years to come, especially if investors demand high risk premia for debt they consider at risk of becoming unsustainable.

What then could be a pertinent policy conclusion from this academic debate? To achieve sustainable growth, the rising public debt must be contained with consistent, medium-term fiscal policies, aiming at a gradual adjustment. Alongside this adjustment, growth must be supported by structural reforms to enhance competitiveness (like in France) and/or domestic demand (like in Germany), and by public and private investment.

At the moment, the excessively tight financing conditions are a stubborn obstacle to the revival of growth, especially in southern Europe. Today’s liquidity trap is in fact a financing trap, in which loans are either not available, or they are available only at prohibitive interest rates. 

All efforts should be made to address this urgent priority, so that exporting and job-creating businesses can get the financing they need to support growth and employment.

Beyond the black and white caricatures of Austerians and Spendanigans, the truth is that fiscal policy in Europe is painted in varying shades of grey. The difficult choices that must be confronted with every decision in these times of crisis mean that pre-conceived narratives provide a poor guide to our complex reality. So it is now better to move beyond the caricatures and close the perception gap. We definitely face major challenges, but it is in the interest of Europeans to stay the course of reform, for the sake of sustainable growth and jobs.

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