Thursday, 2 February 2012

The Euro fiscal pact: the right measure at the wrong time

I am from the true Keynesian fiscal school where fiscal policy should be counter-cyclical i.e. it should be lose during a recession and tight during an economic boom, so that over the economic cycle the fiscal budget would be close to neutral.

I believe in good fiscal housekeeping and awfully detest financial engineering which attempts to cloud fiscal reality.   Such financial engineering seems to be the pet subject of our Minister of Finance who seeks to finance non-revenue generating infrastructure projects like City Gate outside the budget through SPV's and who resorts to  hiding  national debt in the Balance Sheet of national corporations like Enemalta through loans guaranteed by government that ultimately will have to be made good by the taxpayer ( just as the taxpayer is now making good for bank loans of the shipyards which were guaranteed by government).   By so doing, the Minister can appear to meet whatever deficit figure he projects for the official Budget.

I am therefore a firm believer that the sustainability of the Euro monetary union depends on effective  mechanism for enforcing the rules through a new fiscal pact which enforces discipline in a quasi automatic manner.   Certainly for a small open economy like ours this discipline is a welcome necessity as it would protect us from the excesses of politicians who tend to use the public budget as a cookie jar to get themselves re-elected and preserve power, especially in the last year of a legislature.

The problem with the Fiscal  Pact project which Germany is terrorising all EU member to sign up to ( only resistance coming from the UK and the Czech Republic) is that it is the right measure at the wrong time.  It is cyclical not counter-cyclical.

Timing is all important.   The difference between a fresh crisp salad and trash,  is timing.

The fiscal pact discipline would have been great if adopted at inception.   It would not have allowed Greece to borrow beyond its means and would have forced the Italians to address their chronic deficit in good time.    But how can one justify that countries like Spain, Italy, Portugal and Ireland who are already on forced austerity programmes and painful economic restructuring that had been postponed for far too long, should further crush their economies by more fiscal cutbacks when the true solution needs economic growth.

The German excessive discipline could well land the peripheral countries into an unsustainable depression which could challenge their democratic systems.   It could sharpen the divide between core Europe and the periphery as pressure continues to build up inside the monetary union pressure cooker as the core and the periphery move at different speeds and in different directions.

For the Euro system to be saved there is urgent need not so much for additional  fiscal austerity but for increased solidarity.   Germany has to open up its economy to generate import demand so that the crisis countries can fill up the spare capacity resulting from reduced domestic demand by exporting more to the strong countries.

Let me make one prediction.

When on 13th February 2009 I wrote an article expressing doubt about whether the Euro can survive many thought I was going mad.   See this article in this link:

Now I want to make a prediction which I am sure many will find laughable but which I feel quite strongly about.

The Euro problems cannot be solved unless Germany, in a great show of solidarity to save the Euro from blowing up and throw the whole continent into dangerous confusion possibly leading to conflagration, agrees to exit the Euro temporarily and re-join in a restructured monetary union at a conversion rate which would revalue the Deutsche Mark to 1.50 per Euro from the original rate of 1.955.

This is too technical a subject to explain here but I warn that ultimately we will have to come to this solution to avoid serious social unrest in all Europe.

I hope I will be proved wrong, but I doubt it.

 In the meantime Germany continues to play the high and mighty as it makes a feast out of the problems of the periphery but in the process storing problems to explode in the not too distant future.

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