[A-List] EU stability & growth pact: fiscal policy required

["Michael Keaney" <michael.keaney@xxxxxx>]

How many angels can dance on a pin?

William Keegan
Sunday November 24, 2002
The Observer

Economic policy tends to attract simple slogans. In the 1950s and 1960s the
popular complaint was that there was too much 'stop-go'. My old friend Nigel
Lawson, echoing Churchill, coined the criticism 'too little, too late'. Sir
Samuel Brittan entitled one of his books Steering the Economy - but then
proceeded to lose faith in the ability of governments to manage demand and
began to doubt the wisdom of the book's title.
The great pre-war phrase was the need to 'balance the budget'. President
Franklin D Roosevelt is credited with having introduced 'Keynesian' policies
of deficit-financing into the United States in the 1930s but, if I may offer
another JK Galbraith story, Roosevelt had campaigned on a 'balanced budget'
ticket. The story goes that when Roosevelt, as President and father of the
New Deal, was due to return to the city where he had made his promise about
balancing the budget, he agonised over how to handle what would nowadays be
called his 'U' Turn. Galbraith recalls that Roosevelt's advisers came up
with one simple message: 'Tell them you didn't say it.'

These days almost every word politicians utter is thrown back at them.
Labour Chancellor Denis Healey is popularly credited with having threatened
to 'squeeze the rich until the pips squeak' but nobody has ever been able to
pin that quotation down, and Healey says he didn't say it.

What he did say, and it is an aphorism pertinent to today, is 'when you are
in a hole, stop digging'. At a time when the Organisation for Economic
Cooperation and Development is reporting that, at best, the world's economic
recovery has been postponed; and when even our prudent Chancellor, the
scourge of boom and bust, is having to admit that the British economy is now
being bruised by the repercussions of 'boom and bust' elsewhere, Healey's
words should be heeded.

Healey's Law applies to the debate within the UK and the eurozone. There is
a remarkably prevalent layperson's view that if the economy is slowing down,
or even in recession, then taxes should be increased and/or public spending
be reduced. This is the reverse of the sensible approach. It basically means
digging deeper. The trouble in the eurozone is that the mistaken concept
lies at the heart of the stability and growth pact, and even seems to have
been applied by Germany's government in recent weeks, with the announcement
of tax increases at a time when the economic and industrial news gets worse
by the hour.

In Britain more and more people are saying 'Is Gordon's luck running out?'
and 'How's he going to pay for all those spending plans now?' Well, he may
have a long-term problem if it turns out that he has been over-optimistic
about the buoyancy of revenues and the growth potential of the economy, but
in the short run - especially in light of his excessive prudence in those
early years - he should simply take it on the chin and borrow.

In this context he has received welcome and timely support from the Governor
of the Bank of England, Sir Edward George, who said on Breakfast with Frost
that 'it's actually helpful that the fiscal deficit will expand as the
economy grows more slowly than anticipated because that's a buffer, if you
like... an automatic stabiliser which is actually helping to support the UK
economy.'

With regard to the eurozone Sir Edward, who meets his Continental
counterparts frequently, said: 'There is a real question about the
interpretation and perhaps the specification of the stability and growth
pact.' The Governor said the German economy was 'exceptionally weak' and it
was 'tremendously important that the fiscal situation should be allowed to
cushion some of the impact.'

A lifetime's caution lies behind what Sir Edward says in public, and at
first he said that the scope for a larger fiscal deficit was 'provided for
in the stability and growth pact but there are questions of interpretation
and I think the interpretation is in danger of being very rigid'. Going on
to question the 'specification' of the pact was strong stuff by central
banking standards, even though qualified by the 'perhaps'.

The scope for 'interpretation' of the pact is much stressed by inveterate
campaigners such as the British MEP Chris Huhne. But, frankly, the small
print on which they base their case is so small that the whole thing calls
to mind medieval debates about how many angels can dance on the head of a
pin. There is certainly a debate going on, with the Germans tending to
attack the European Central Bank (the stability pact was a German invention)
and the French castigating the pact. Meanwhile, the European Commission,
while clearly having strong on-the-record views about the 'stupidity' of the
pact, rather likes being the custodian of budgetary discipline and of the
so-called 'excessive deficit procedure'. It is good that there is a debate
going on, but it is surreal that the Commission is invoking the excessive
deficit procedure (which threatens 'fines' if countries do not get their
budgets in order) at a time like this, even if it is bending over backwards
to be flexible.

The gravity of the situation is illustrated by the intervention made by
former Bundesbank President Karl Otto Pohl at a conference in Berlin last
weekend. 'In the present situation, price stability or inflation are not the
main problems,' said Pohl. 'The main problems are stagnation or even a
recession.'

This is good stuff coming from one of the principal architects of the ECB
itself. One of the problems is that the entire edifice of rules surrounding
the ECB, the stability pact and the excessive deficits procedure was
constructed at a time when fiscal policy - alterations in tax rates and
public spending to affect output and employment - was out of fashion.

It was a long process of erosion. When the world moved from the Bretton
Woods system of fixed exchange rates to floating rates, monetary policy
began to play a bigger role. And in the US, the powerhouse of academic
economics, congressional wrangling over tax changes meant that fiscal policy
could not be as flexible as in Europe.

The eurozone is a fixed exchange rate system and needs greater use of fiscal
policy to compensate for the 'one size fits all' monetary policy. In the UK
the tendency has been to play down fiscal policy and emphasise achieving the
inflation target. But it is noteworthy that the scope for fiscal policy is
acknowledged in the Treasury's new macroeconomic bible Reforming Britain's
Economic and Fiscal Policy.

'It is important that the chosen rules allow sufficient flexibility to react
sensibly to economic developments - the right balance needs to be struck
between a rigid mechanical approach and an approach based on unfettered
discretion,' states the Treasury.

A world of recession or slow growth and negligible inflation is crying out
for the revival of fiscal policy. Treasury officials know this.

But when they look up references to fiscal and monetary policy on various
websites, they find the subject of fiscal policy needs a lot more nurturing.