The consensus that dominated macroeconomics from the 1980s, and framed the European institutions’ thinking in terms of macroeconomic governance, relegated fiscal policy to the dustbin of history. If anything, standard macroeconomic thinking relied on monetary policy to react to economic shocks. The 2008 crisis challenged this consensus, as monetary policy alone proved ineffective in counteracting the spectacular drop in economic activity. Indeed, deleveraging and private sector pessimism about the recovery led to stagnation in consumer spending that only public intervention via direct spending could compensate, as it had done in the 1930s.
Olivier Blanchard recently stated that “fiscal policy has to become a macro tool again in a major way and what amazes me is how little work there has been on fiscal policy as a macroeconomic tool since 2008”. Some things though we have learned: among others, that the size of multipliers is large during recessions, and that fiscal consolidation may have permanent negative effects. The debate on secular stagnation, revived by Larry Summers, is particularly instructive: if advanced economies face a long period of chronic demand shortage, excess savings and low interest rates, then fiscal policy activism, via public investment, should not be limited to standard Keynesian short-term stabilization, but sustained on a semi-permanent basis until full employment is restored.
This reassessment of fiscal policy is now affecting Europe: austerity is perceived (albeit discreetly) as ill-timed and counterproductive even within EU institutions, and a political debate has been taken up even among government coalition forces in Germany, as a recent interview of Sigmar Gabriel shows. The link between pro-cyclical policies, the persisting weakness of the economy, and the parallel rise of populist movements, increasingly appears as the main problem that EU policymakers face today.
Nevertheless, this still timid change of tone does not entail, as it should, a serious discussion on a coherent reform of European institutions, which still reflect the pre-crisis consensus. The Stability and Growth Pact (1997) required government budgets to be in equilibrium over the cycle, thus limiting fiscal policy to automatic stabilization and banning any active discretionary intervention on the part of governments. Paradoxically, given this straitjacket, European institutional rigidity was increased from 2011 by the gradual adoption of the Fiscal Compact. It is not surprising then that what started in 2008 as a US-generated crisis rapidly became a European-only quagmire of unemployment, deflation, stagnation and political discontent; with the result that disintegration forces are increasingly strong across the continent. The adoption of a rule like the Fiscal Compact – which no other country in the world has ever considered, and with good reason – has been untimely, unfortunate and unequivocally wrong. Its uniquely negative effects, as the experience of Italy clearly shows, lie in the perverse features whereby, even if a government is allowed to renege year after year on the promised path toward a balanced budget, it is still required, every year, to recommit to a medium term (3-4 years) adjustment toward that balance. In so doing, business expectations are negatively affected, private investment plans are postponed, and stagnation becomes a permanent feature of the economy.
Can something be done, quickly and pragmatically, to stop this abysmal state of affairs? The answer is yes. 2017 is not only the year of crucially important elections, above all in France and Germany. At the end of the year, EU governments will have to prepare for a formal decision on the fate of the Fiscal Compact. Indeed, after a five-year experience of what has been so far only an intergovernmental agreement, signed-up EU members will have to decide, by unanimous consent, whether to definitively insert the Fiscal Compact into the EU Treaty or not. If a number of important countries were to veto that move, this could set in motion a profound rethink of the appropriate fiscal policy infrastructure supporting the euro zone in future, one consistent with recent developments in macroeconomics.
2017 could therefore be the year in which EU policy-makers finally acknowledge that macroeconomic management requires a drastic shift and start reshaping institutions accordingly, adapting them to the high-level goals enshrined in article 3 of its Treaty: to aim “at full employment and social progress … while combat[ing] social exclusion and discrimination”. One can only hope that this occasion is not wasted by our leaders. There may not be many others.
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