European public finances under pressure?

At its meeting on 8 November, the Governing Council of the ECB decided to reduce the minimum bid rate on the main refinancing operations of the Eurosystem by 50 basis points to 3.25%. This decision was welcomed even if it could have been taken earlier, most of the forward looking “informations ” on which it was grounded being already available: the slowdown of the expected rates of growth of both output and prices in the Euro area. If we consider current forecasts for inflation (1.8%) and growth (1.5%) in the area for 2002, that means that monetary policy is neutral, putting fiscal policy under pressure. In my last briefing paper, I exposed the reasons why the job of stabilisation should better be left to monetary policy than to discretionary fiscal policy. The policy mix adapted to present circumstances should thus imply both an expansionary monetary policy and a neutral fiscal policy, which means that the automatic stabilisers should be left to play their role. With a neutral monetary policy (but may be the ECB will soon take some steps in the good direction), there is a strong incentive for government to use discretionary fiscal policy to remedy to the present slowdown of growth. This incentive is all the more powerful that the dramatic events of September 11, are clearly calling for non-market governing forces to re-establish confidence. Considering the economic consequences of these events, one may question the credibility of rules – the stability and growth pact – if these rules impose further limitations on sovereignty in Europe. Not only does the pact limit public deficits to 3 % of GDP for each country, despite their different initial conditions at the entry in the area, but it constrains governments to commit to medium-term fiscal balance. Under exceptional circumstances – as the ones we undoubtedly are – it is unlikely that these rules if they are obeyed to the letter, will lead to “good” economic policy. ha l-