Dublin Opinion

Greece is NOT the reason why the Euro is failing. It is a symptom of the structural problems which have been there from the start.

The long quote below is from a speech Trichet made in Dublin in 2004. I came across it today in the National Library, filed with the annual reports of the Central Bank.

Trichet highlights the problems before dismissing them as unfounded. The solutions he put forward, of course, are the very ones which failed.

The quote ends with a belief in supply-side economics as the best provider of growth there is - the very argument being made today with regard to the ECB and its new-found ‘growth’ card: liberalize labour markets, cut taxes for business, and the market will sort out the rest.

To paraphrase the title of a Wedding Present Song, what did your last excuse die of?

let me stress that we Europeans have been very bold in creating a single currency in the absence of a political federation, a federal government and a federal budget at the euro area level.

Some observers were indeed arguing that without a federal budget of some significance the policy mix would be very erratic, depending on the random behaviour of the different national fiscal policies of the member countries. They were also arguing that without a federal budget it would be impossible to weather, with the help of the fiscal channel, asymmetric shocks hitting one particular member economy.

In this respect, the very existence of the Stability and Growth Pact actually allows to refute these two arguments: first, the Maastricht Treaty and the Pact provide a mutual surveillance by the “peers”- i.e the Ministers of Finance - of national fiscal policies; second, by calling upon Member States to maintain their budget close to balance or in surplus over the medium term, the Pact allows the automatic stabilisers to play in full in countries facing an economic downturn, without breaching the 3 % ceiling for the deficit. Beyond these economic underpinnings, other considerations are worth mentioning: a fiscal policy set according to rules adds to macroeconomic stability by providing agents with expectations of a predictable economic environment; this reduces uncertainty and promotes longer term decision making, notably investment decisions, and economic growth; in addition, sound fiscal policies contribute to lower risk premia on long term interest rates and thus support more favourable financing conditions; finally, fiscal discipline prevents spill-over effects from one country to another in the form of higher interest rates.

Some people argue that fiscal consolidation is detrimental to demand and economic activity. I would maintain that wealth and expectational effects of well-designed consolidation programmes might very much reduce and possibly even outweigh the traditional Keynesian multiplier effects of fiscal policy on demand and activity. If fiscal consolidation is perceived by the private sector as a credible sign that public spending will be permanently lower in future years, households will revise upwards their expected permanent income in anticipation of lower future taxes. Therefore, current and planned consumption will also increase.

In addition, fiscal consolidation might improve long-term financing conditions by way of less demand on the savings pool (reducing crowding out) and lower risk premia on government paper. Hence, wealth effects prompted by lower nominal and real interest rates would support larger consumption. Furthermore, following more favourable financing conditions, private investment is also likely to increase.

The case for expansionary effects on the supply side, via an improved competitiveness of the economy, is also important. If fiscal consolidation can induce moderating effects on wage demand, relative unit labour costs might decrease, with positive medium-term effects on real GDP growth through a greater competitiveness of the productive sector. Such effects are buoyed if lower expected tax rates and more efficient public expenditure enhance the working incentives and the investment environment.

[Central Bank and Financial Services Authority of Ireland. Central Bank Whitaker Lecture. Dublin, 2004. Filed in National Library of Ireland with Central Bank & financial Services Authority of Ireland Annual Report 2005. 1K 341 yr2005]