Basta with the stability pact

Let’s not get carried away about the unravelling of Europe’s Stability and Growth Pact.

Sure, the deal reached in Brussels to allow Germany and France to avoid paying big fines because their budgets have breached the pact’s deficit requirements is another sign of how the European Union’s leading powers set the rules of the game for the EU.

Sure, it probably also sends the wrong message to the nations in Central Europe, who are to join the EU next year and then face another round of moves to knock their finances into shape before abandoning their national currencies and signing up to Europe’s common currency.

In addition, the Franco-German deal could mean that the European Central Bank might be less inclined to deliver another interest rate cut.

But German Finance Minister Hans Eichel was quite right to say “basta” to Brussels’ demands for further round of big savings in a bid to force Germany’s budget deficit, as a percentage of GDP, back down under the magic three percent barrier.

After all, endless government cutbacks in the middle of an economic downturn were not getting anyone anywhere.

Why is it 3 percent anyway? Why not 3.2 percent or 3.4 percent?

The truth of the matter is that the 3 percent figure is purely arbitrary and was essentially settled upon during the final years of the Kohl government as a way of appeasing Germany’s once powerful central bank, the Bundesbank, which was never particularly enthusiastic about the introduction of the euro.

It was later dressed up as being something that “the Germans” wanted in return for agreeing to give up the much-loved mark and replace it with what was then the new and untested euro.

But considering the enormous cuts in public spending in Germany that have followed both the arrival of the euro and the signing of the stability pact you would have to really question whether such a dramatic clampdown on a range of government services is really what “the Germans” wanted.

To be sure, it should not be surprising that such a strict and possibly ill-conceived fiscal agreement would unravel when he economic times got tough.

For all the talk of how the stability pact was needed to shore up the creditability of the euro in financial markets, it is worth noting that the euro barely moved in the wake of the announcement that EU finance ministers had agreed to turn a blind eye to the failure by France and Germany to fulfil the pact’s rules.

However, when governments were in recent years attempting to comply with the pact’s rules and criticism of its operations was more muted, the euro was on a downward path, hitting at one stage an all-time lows of about 82 cents.

Now, against the backdrop of a blaze of reports about the pact’s future, the euro has been zooming ahead climbing to all-time high of nearly USD 1.20 earlier this year. It is expected to charge ahead to USD 1.25 in the coming months.

The reality is that other factors (notably the comparative performances of the US and European economies) have been at work in shaping events on the foreign exchange markets.

In much the same way, it is likely to be other reasons such as the surge in the euro and dwindling inflation that finally force the ECB to cut rates again.

But then sections of the financial markets never really had much faith in the pact. They knew all along that tough fines for offenders would never be enforceable and that the pact’s main aim was to set targets.

Despite the cries of shame about Germany and France lording it over smaller European nations and setting a bad example for Central Europe, it has not really been in the eurozone’s best economic interests to have its two biggest economies struggling to meet tough budget rules at a time of a sharp global slowdown.

It would be interesting to see how many jobs have been lost in recent years as a result of the dramatic squeeze on public spending as a consequence of governments scrambling to meet the formula drawn up by the stability pact.

In particular, a massive fine for Germany for its failure to comply with the pact could throw into doubt the future of big tax cuts that are due to be introduced in the country next year and which are aimed at ensuring that Europe’s biggest economy remains firmly on course to an economic rebound.

No one in any authority is really suggesting that the stability pact should be abandoned. What needs to happen is that the pact must be reformed to be made more responsive to prevailing economic conditions.

No one is also doubting the fiscal goals of the stability pact and its success in setting fiscal guidelines or budget targets for euro currency bloc member states.

It is just that those goals might take a little longer to reach as the European economy moves through different stages of the business cycle.

November 2003

Subject: German news