Wednesday, December 10, 2008

Fiscal Conservatism

Contrast Paul Krugman's puzzlement at German inaction (below) with Jürgen Stark's call for fiscal conservatism:

Any appropriate approach to fiscal policies in the current situation must be based on a number of sound principles. It is essential that the public's confidence in the soundness of fiscal policies is preserved. This requires that fiscal sustainability is guaranteed. Equally important, the EU's rules-based fiscal framework must be fully applied and its integrity preserved.

In practical terms, we should recall that the automatic fiscal stabilizers in the euro area -- policies that dampen economic cycles without direct government intervention -- are large and amount to about 1% of GDP. As the tax burden diminishes with subdued economic activity and government expenditures increase, for example in the form of unemployment payments, public budgets provide a powerful source of fiscal support for a weakening economy. And this type of stimulus is automatically reversed when economic conditions improve.

Only a few countries have the scope to take additional action. Where such room for manoeuvre exists, additional budgetary measures have to comply with the "three T's" in order to be effective. In the current circumstances, we cannot, and should not, risk adding a fiscal crisis to the financial turmoil and economic downturn.


Stark is a member of the Executive Board of the ECB. He seems barely to notice that there is a crisis in progress, let alone acknowledge its dimensions. It is interesting to compare fiscal conservatives in America with this echt-European representative. Martin Feldstein favors a large government stimulus. So does Greg Mankiw, although he would prefer tax cuts as an instrument to increased government spending. In stark contrast, Stark wants to stand pat and allow "automatic stabilizers" to do their work, as if this were an ordinary recession. European monetarism is a stern and demanding creed.

ADDENDUM: In fairness to Stark, it should be noted that some European countries have more to worry about when it comes to debt than others. Spreads on sovereign debt have widened recently, with Greek bonds, for example, trading at a premium of 185 basis points. Investors clearly do not regard Euroland as an economic unit, and, as noted here previously, Feldstein worries that these disparities may eventually crack European unity (Barry Eichengreen disagrees, and I largely agree with Eichengreen, however). The question is one of emphasis and intention, and if Stark's intention is to justify German reluctance to stimulate, his statements assume a political coloration inappropriate for a central banker.

4 comments:

Anonymous said...

Anatole Kaletsky used to spend many a column denouncing what he amusedly called the "sado-monetarism" of the ECB. Admittedly, the looseness of the Greenspan Fed doesn't seem so wise now, but Stark's attitude is indeed odd and worrying.

Unknown said...

I wouldn't use Kaletsky as a reference though. He was the delusional emu who tried to persuade the British public for years that monetary union would not happen.

What I find amusing in Stark's statement, though in a Galgenhumor way, is that he appears to be under the impression that automatic stabilizers are a policy. The reason they are called automatic is precisely that they are the absence of policy whereas choosing to prevent them from working out is a (regressive) policy.

Now, Stark may be somewhat delusional regarding the scale of the current crisis, but he does have a point. It is a fact that most Eurozone governments have proved incapable on several occasions when times were good to scale back their expenditures following an expansion thereof during downturns. As a result, it is a fact that structural deficits (check out the numbers from the appendix to OECD outlooks for instance) tend to remain, well, structural. This was true during the second half of the nineties and again during the recent expansion earlier this decade.

TexExile said...

As long as we're trying to be fair to Stark (even without endorsing his conclusion), it is also worth noting that the automatic stabilisers tend to be greater in most European countries than in the US and that any counter-cyclical fiscal policy in the US has to take account of the fact that states' fiscal policies tend to be pro-cyclical. Some degree of federal stimulus may be needed in a downturn just to keep the overall fiscal stance neutral (i.e. to offset spending cuts by cash-strapped states).

Unknown said...

Good point, Tex.