When rules are there to be broken
It has become an article of faith for Europe-watchers that the one thing holding together the single currency area is super easy monetary policy. Yet, in light of Brussels deficit policing bureaucracy having recently been revealed as a toothless tiger, expansionary fiscal policy can perhaps be added to the list. It is hardly news that Europe is backtracking from German-dictated austerity, but for the first time officials are openly admitting that their “excessive deficit” rules are there to be broken. Italy, Spain and Portugal will all miss fiscal targets this year, and while bad boy Greece remains locked in a debtors’ prison, this relaxation seems a clear response to the current populist political upsurge.
Specifically, the diminution of Berlin’s political authority over the last year has provided cover for breaches of fiscal rules agreed to back in 2011. The result for Italy, Spain and Portugal is that fiscal policy should be broadly neutral this year, while an enforcement of scheduled deficit targets would have imposed a fiscal drag. The direction of travel points to drag eventually turning into a tail wind. As such, the eurozone is evolving a more flexible set of fiscal rules more akin to the old growth and stability pact, which saw both Germany and France breach their obligations in the early 2000s. Consider the following slippage.
- Spain’s deficit blew out to 5.1% of GDP last year compared to a target of 4.2% in 2015 and 2.8% in 2016. Now the plan is for a deficit of 3.7% of GDP in 2016 and a deficit of 2.5% in 2017.
- Portugal was due to record a general government deficit of 2.7% of GDP in 2015. In fact the deficit amounted to 4.4% of GDP, and Brussels is now calling for it to fall to 2.3% in 2016.
- Italy’s deficit is below 3% of GDP, but it faces scrutiny because of the need to trim a public debt that has risen to 133% of GDP. This month it was granted “unprecedented flexibility” in setting its budget, with discretion worth 0.85% of GDP. The deal requires Italy to submit a budget agreeable to Brussels by November and was ostensibly granted due to Rome pushing through a series of structural reforms.
In reality, these agreements reflect less some wily technocratic solution than a crude bargaining process between national capitals and Brussels. In Italy, reformistinclined Prime Minister Matteo Renzi faces an autumn referendum to gain consent for constitutional reform that aims to make governments stronger and so allow the passage of controversial legislation. These changes face fierce opposition and Renzi has extracted flexibility from Brussels on the basis of him being the best hope to reform Italy before it slides on a trajectory out of the eurozone. Similar logic applies to Spain, which has a national election on June 26, that Brussels will desperately hope returns centrist parties. Portugal’s new socialist government has capitalised on its mandate to backtrack on previous budget commitments with Brussels and win more flexibility.
No doubt, Brussels will seek to re-impose budgetary discipline once the 2016 electoral calendar has cleared. However, our point is that the genie is out of the bottle and it will be hard to re-impose rules-based budgeting so long as Southern Europe faces acute deflationary pressure as fiscal tightening will make matters worse.
Moreover, the political stakes are set to rise with next year’s presidential election in France likely to see the enforcement of fiscal rules slip further. Such a trend should support growth in the short term, but it does undermine any notion of the eurozone converging towards a shared future, something that will raise temperatures in Berlin. Rather, this looks like another example of centrifugal forces gathering strength.