|Another re-run in Europe|
|Saturday, 10 December 2011 00:00|
We’ve seen the austerity pact before, will it work now?
It’s early days in Europe’s crisis summit, and there will be several highs and lows before there’s a final sense of where
Europe is headed—the markets rose when it seemed ECB chief Mario Draghi was assuring he’d backstop troubled countries, they fell when he said he’d been misunderstood, then rose again when an agreement was reached to give the IMF ¤200bn to lend to troubled European countries and when details of the new ‘fiscal compact’ were out. The ¤500bn permanent European Stability Mechanism is to come in place a year early by July 2012 and, for a year, will run in parallel to the ¤440bn temporary European Financial Stability Facility. New stress tests have raised the fund requirements of European banks.
But none of this may be enough to stave off market panic for long—this requires an unconditional bailout commitment from the ECB. The ‘fiscal compact’ is essentially the old Stability and Growth Pact in a new form—automatic penalties will get triggered off when the 3% deficit target is breached, but we have to see whether this works in practice. In 2003, when France and Germany were in breach of this, the pact was suspended for a while. Given Chancellor Merkel’s insistence on the pact, it’s not surprising that as many countries have accepted it since the alternative is chaos, but the old issues come up again—how does a country in trouble get out of it when policy options like inflation and currency devaluation are not available? How countries will react to faceless bureaucrats taking over their sovereign functions remains to be seen – though it insists circumstances were different, the IMF has often been accused of applying different standards to different countries in trouble!
Assuming the ‘fiscal pact’ holds, the larger question is whether it is the right solution. Commentators like Martin Wolf have argued the problem is not one of excessive spending (http://bit.ly/tKn3xk) since till the 2008 crisis, every country except Greece had a deficit below 3%; nor would a debt criterion pick up the crisis countries. The only metric that does, he argues, is the current account deficit since the 2008 crisis resulted in external funding drying up—if external adjustment is the issue, fiscal correction will only worsen things. If, as Paul Krugman argues, it is the running of current account surpluses that rescued Germany from such a fate a decade ago, then “if Southern Europe is going to shrink its trade deficits somebody has to move in the opposite direction”. Much the same applies to the new stress tests. One, given the amount banks need to raise is just 8% more than that estimated two months ago, they look unreal. More important, since raising capital is difficult, there’s nothing to prevent banks from just shrinking their books to achieve the necessary capital ratios. But we live in hope.