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The euro area relies excessively on monetary easing


A sculpture depicting the Euro logo is pictured in front of the former headquarter of the European Central Bank in Frankfurt, Germany, on Feb. 7, 2018

Daniel Roland | AFP | Getty Images

Fiscal consolidation within the European monetary union still remains the order of the day.

At the moment, 40% of euro area countries are running growing budget surpluses, or roughly balanced public sector accounts, with their public debt at or below the union’s mandated 60 percent of the gross domestic product.

The other half is still struggling with budget deficits and public debt ranging from 100% to 182% (Greece) of their total economies. In spite of their high unemployment, those countries are under constant pressure from the European Commission (the executive body of the European Union) to cut public spending and raise taxes to balance their accounts and run substantial primary budget surpluses (budget balances before interest charges on public liabilities) to keep government debt on a steadily declining path.

For deficit countries, easy money is the essential life support. And for the euro area as a whole, the monetary accommodation by the European Central Bank is an appropriate attempt to partly offset a continuously tightening fiscal stance causing intra-area dissent and exacting high costs in terms of jobs and incomes.

Pro-cyclical fiscal austerity

France — about one-fifth of the euro area economy — is a vivid example of economic, social and political problems encountered in its epic quest for fiscal virtue.

Seeking to adjust its welfare state to the post-crisis world, France cut its budget deficit from the peak of 7.2% of GDP in 2009 to 2.8% in 2017, well below the monetary union’s rule of 3% of GDP. And then President Emmanuel Macron wanted to go further, and faster, with deficit cuts and fairly radical reforms of the French economy and society at large – apparently to impress Germans with his big ideas about re-founding the European Union.

Predictably, public spending cuts and tax hikes ended up in violent riots last November, triggered by rising fuel prices but quickly spreading to demands for higher minimum wages, wealth taxes, better living standards, resignation of the president and prime minister, etc. That social movement, called “yellow vests,” calmed down gradually after fuel taxes were withdrawn, minimum wages raised and taxes cuts granted. But the public discontent is still simmering, as acknowledged by Macron earlier this month. The “yellow vests” also reminded everybody that they would be back on the streets next September.

The rush to quell the unrest was a costly affair: The French budget deficit in the first quarter of the year surged to 3.6% of GDP from an average of 2.5% in 2018, putting the deficit target of 2.1% for this year out of reach. The French media reported last week that the government was desperately looking for some 3 billion euro in additional revenue, part of which is apparently a 3% tax on digital services that could cause a trade and tax war with the United States.

Italy and Spain are also experiencing fiscal difficulties at the time of slowing growth, high unemployment and unsettled sociopolitical conditions.

The ECB can’t do it all

Italy, barely emerging from two successive quarters of negative growth, is under pressure to cut budget deficits, estimated at an overly optimistic 2.4% of GDP for this year. The EU Commission is threatening sanctions to keep Rome bearing down on its huge public debt of 134% of GDP. That’s a tall order indeed for a country experiencing an unemployment rate of 10%, with 31% of its youth out of work and a meaningful future.

Spain, with an unemployment rate of 13.6% and half of a million (31.7%) of its youth looking for a job, has no stable government three months after the last parliamentary election. But Madrid is also under pressure from the Brussels Commission to cut the budget deficit to 2% this year (from 2.5% in 2018), and to make some progress on reducing its public debt that has stabilized at 100% of GDP.

Ominously, negotiations to form a government failed last week on labor market issues because the left party Podemos asked to head the ministry of labor to create more jobs and better worker incomes.

As things now stand, Spain is likely to go to a new round of elections in early November, which means that it won’t have a functioning government this year to attend to issues of public debts and deficits.

Putting together France, Italy and Spain, you get nearly half of the euro area economy where growth and employment are taking a backseat to pressures of cutting public spending and raising taxes.

Is there any wonder, then, that the ECB has to offset some of the euro area’s fiscal tightening — large budget surpluses and constant pressure to reduce public debts and deficits — under conditions of slowing economic growth and high unemployment?

Strangely, the ECB is not talking much about fiscal policy. It is hewing instead to its mandate by saying that its loose credit policies are in response to quasi deflationary cyclical conditions, where consumer prices in June registered an annual increase of 1.3% — considerably below the ECB’s medium-term target of 2%.

One can understand the ECB’s discretion, but it is incomprehensible that the Eurogroup, a forum of euro area finance ministers acting as the monetary union’s informal economic government, condones the madness of pro-cyclical fiscal policies.

The EU Commission and France are confronting the U.S. on trade and taxes, but they have no courage to confront the damaging economic policies by euro area countries running large and growing budget surpluses and living off partners with huge net exports.

Investment thoughts

The euro area is in a familiar place: Countries exploiting their neighbors with indecently large trade surpluses are calling the shots.

That is setting the stage for social unrest, political instability, intra-area clashes and hostility toward EU Commission policies apparently dictated by mercantilist task masters. France, Italy and Spain need space to address what Macron calls “injustices” fostered by years of high unemployment, economic precariousness and social exclusion.

Monetary policy alone cannot deal with that. The ECB will use the window of tame inflation to help against fiscal austerity, but patient, sensible and broad-based public policies are needed to tackle deeply ingrained structural problems.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.


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