The EU's instability pact

By ANDREW SMITHERS
Updated:

 

THE European Union has a stability pact. The idea is that member countries should have budget deficits of less than 3% of gross domestic product. In a recession, it makes sense to have large deficits. Raising taxes or cutting public spending merely makes recessions worse. In practice, therefore, the agreement is not a stability pact, but an instability one.

The European Commission, as guardian of the absurd pact, has criticised Britain's budget policies in the recent past, but it is most concerned about Germany and Portugal at the moment.

Having Germany in the corner, wearing the dunce's cap, is an example of poetic justice. It was largely at Germany's insistence that the agreement was reached in the first place.

When the euro was little more than a gleam in the Commission's eye, one objection to it was the idea that nations would go wild once the currency was introduced. When countries borrowed in their own currencies, they could not go bust. They could always repay debt by printing money. In the era of the single currency, they can borrow in euros but not print them. Bankruptcy is now possible.

There are two answers to this. One is not to worry and let them go bust if they are silly enough. The other is to try to stop them.

There is a sensible answer and a silly one. Faced with a choice on economic matters between a sensible option and a silly one, it is always odds-on that European politicians will choose the latter. Once again they lived down to expectations.

The wish of German politicians was granted and the stability pact agreed. Now that Germany is on the way to breaking it, the Commission has its knickers in a twist.

IF THE Commission had taken its duties seriously, it would have warned Germany. This would have created a political storm. It would have been very embarrassing for the German government. In addition, our own Chancellor Gordon Brown - smarting under the Commission's previous strictures on his Budget plans - rushed to Germany's support.

The Commission was then in a quandary. It only had the support of the Netherlands, Belgium, Austria and Finland. The heavyweights were against it. On the other hand, it was worried that failure to support the stability pact would weaken the euro.

The weakness of the single currency is, of course, extremely helpful to Europe. Without it, the current slowdown would have turned into a full-blown recession. But the Commission is European enough to feel that a grasp of economics is unpatriotic. Fudge therefore ruled. EU finance ministers have agreed no formal warning will be given to Germany or Portugal, on the understanding that they will try to do better in the future.

The official view now seems clear. The stability pact is a good idea, provided it is not taken seriously. This is good news. If the world economy stumbles, higher budget deficits will be needed to prevent a painful recession.

www.smithers.co.uk

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