Tuesday, December 6, 2011

Golden Rules

Curiously, the French have adopted the term règle d'or for the balanced budget amendment that Sarkozy wants to inscribe in the Constitution and, together with Germany, extend to all of Europe:
Paris et Berlin ont annoncé parmi leurs propositions l'adoption d'une "règle d'or renforcée et harmonisée au niveau européen", que les pays de la zone euro s'engageraient àmettre en place pour rassurer les marchés et améliorer la gouvernance économique européenne.
The original golden rule is of course "Do unto others as you would have them do unto you." The fiscal golden rule seems to be rather to do unto yourself what you have already inflicted on the least fortunate among you.

But Le Monde notes that the German golden rule, the presumed model for the French, is less than meets the eye. It imposes a limit of 0.35% of GDP on the structural deficit but allows for "conjunctural variations":
"en cas de catastrophe naturelle ou de situation d'urgence exceptionnelles qui échappent au contrôle de l'Etat et compromettent considérablement les finances publiques, ces limites supérieures de l'emprunt peuvent être dépassées"
Despite the agreement in principle between Sarkozy and Merkel, a great many details remain to be specified regarding any trans-European golden rule, and in these matters, as always, the devil is in the details. National budgets are of course subject to all the vagaries of the business cycle. "Prediction is hard," Yogi Berra said, "especially about the future," and that is particularly true of budgetary matters. Structural deficits depend on the measures in place to finance entitlements, and these vary widely from country to country. The nature of the oversight to be applied--who will judge? what baseline assumptions will be used? how will long-term investments be charged against annual budgets? etc.--has yet to be worked out. And what exceptions will be allowed to accommodate the inevitable "conjunctural variations?"

Of course, in one sense, none of this matters. The only immediate question is whether the ECB will be satisfied by the signal of good intentions from France and Germany if accompanied by murmurs of support, or at any rate non-hostility, from other EU leaders. But in the medium term investors will have to be convinced that the rhetoric of "golden rules" is not mere eyewash or, worse, a return to "the gold standard albeit with a German accent" (I owe this phrase to Henry Farrell). The gold standard, you will recall, ensured the propagation of economic contraction from one nation to another in the 1930s: see Barry Eichengreen, Golden Fetters. The international golden rule seems destined to accomplish the same feat: ratcheting up contraction by forcing countries to rein in spending whenever economic activity decreases, ensuring a procyclical downward spiral of diminishing consumption, trade, employment, and prices.

If you read the Mundell paper on optimal currency areas to which I linked yesterday, you will see that one of the requirements is for fiscal transfers from prosperous to less prosperous regions to counter negative asymmetrical demand shocks. This is precisely what an EU-wide golden rule will prevent. Hence a measure designed to save the euro in the short run may prove to be its undoing in the long run, unless some other form of adjustment is put in place. Ultimately, what Sarkozy, if not Merkel, seems to have in mind is a fiscal union at the federal level able to collect taxes from all member states and make transfers as appropriate. But there is no guarantee that the process Sarkozy and Merkel have launched will reach that goal, whereas it seems much more likely that a golden rule will be enforced as a short-term fix. By adopting this expedient, which may alleviate the pressure for deeper structural change, the long-term solution may become even more elusive than it already is.

1 comment:

Anonymous said...

I may not understand everything and thus I may be showing my ignorance, but it feels as if our leaders weren't up to the task.
Overall, I find every new development more worrisome than the previous one.