Golden rule has no Midas touch

Government wants the 'golden rule' entrenched in the Constitution - so says an article in The Times today.

I disagree with this for two very strong reasons.   Firstly because I am extremely cautious about any changes to the Constitution and I am adamantly against any change which is entrenched requiring two-thirds parliamentary majority vote for any future changes thereto.  Secondly because, economically speaking,  this golden rule that budgets must be balanced on a permanent basis is a heresy and certainly it has no Midas touch.
Let's discuss these points one by one.

Avoid changes to the Constitution

This knack of talking liberally about changes to the Constitution as if it were just another law, is irresponsible.   The Constitution is the mother of all laws and as the Board of Directors of a Company has no power to change the Memorandum & Articles of their Company ( that power belongs to the shareholders) Parliament should be very cautious of taking a liberal attitude to constitutional changes.  If anything such changes should be referred to the shareholders of the Constitution, the Maltese nation, for their approval through a specific referendum.

And attempts to make constitutional changes entrenched and subject to two-thirds majority smacks of arrogant claims of prescience about future conditions that should continue to be unconditionally constrained by the constitutional changes that are proposed to be entrenched.    No one has such prescience  and those who claim it are dangerous people and should not be trusted in our kitchens let alone in parliament.

No Midas touch

I already wrote about this in my article "euro fiscal pact: right measure at the wrong time".  See link.

http://alfred-mifsud.blogspot.com/2012/02/euro-fiscal-pact-right-measure-at-wrong.html

As a small country with an open economy there is much to be gained by adopting virtuous fiscal policy avoiding chronic fiscal deficits.   A small country like ours depends for its economic development much more on the demand existing in our export markets than on our own internal demand and therefore there are strong demand leakages which make fiscal policy as an economic tool not very effective.  But adopting such policy for large countries across the whole EU is economically brutal and socially explosive.

No sooner had the countries signed up for the fiscal pact at the last EU summit, which was discussing the need for stimulating economic growth, the Spanish Conservative Prime Minister was quoted as saying that Spain, with an unemployment rate of 25%, cannot possibly stick to the budget reduction targets and would be requesting the EU to adopt a more flexible approach.  He expressed the sensible view that forcing austerity on an economy already in recession could crush it and shrink it, rendering the fiscal reduction objective less and less likely.

There are two clear reasons why on an EU basis the Golden Rule is economic fallacy:

Firstly fiscal policy has to be seen in context of the overall economy and particularly the Balance of Payments position.  If a country like Germany has a fiscal deficit but a strong Balance of Payments surplus the fiscal deficit is very tolerable as it is an internal affair and could be addressed relatively easily by tax adjustments on a strong private sector ( as evidenced by the balance of payment surplus).   However even a fiscal surplus in the context of a large balance of payments deficits could not be tight enough.   Spain and Ireland were fiscally in surplus before the financial crisis of 2008.  Both however had a hugely leveraged private sector as was evidenced by chronic balance of payments deficits; when the property bubble in both countries burst, the fiscal surplus quickly switched to a chronic deficit.  No Golden Rule could have avoided that.

Secondly demand management in the true Keynesian sense remains an important economic policy tool for the larger economies.   Countries need not have a permanently balanced budget.  When the economy slips into recession a switch to responsible deficit fiscal policies makes sense.  In true Keynesian scriptures the budget should be balanced over the economic cycle not in each and every year during the cycle.   Otherwise we can just as well elect robots to manage our economies.

The Golden Rule should be adopted with great caution and should allow room for flexibility when needed and should certainly not be entrenched in the constitution.   Otherwise we will be spending our time exploring how to cheat it by creating SPV's to stay within the word but not within the spirit of the Golden Rule.   We are doing that already now , let alone if we strap our selves with the misnomered Golden Rule.