Eurozone Hard Pressed: 2% Fiscal Solution Deferred

One leading anti-recession idea for the moment is a global fiscal stimulus amounting to 2% of the planet’s GDP.  The precise math behind this calculation is still forthcoming, but it obviously assumes a big stimulus in the US and also needs to include a pretty big fiscal expansion in Europe.  (Emerging markets will barely be able to make a contribution that registers on the global scale.)

What are the likely prospects for a major eurozone fiscal stimulus?  My presentation yesterday on this question is here.  The main points are:

The pressure is really on euro sovereigns with relatively weak fiscal positions.  This may not seem fair, in the sense that the crisis started far away (in some sense), but that is how crises work.

Whether or not the global recession is bad, countries like Greece and Italy (and a set of countries now known in the markets by the unfortunate acronym of PIIGS) are being pushed towards urgent fiscal austerity, i.e., the opposite of expansion.

They could, of course, get some sort of help from stronger eurozone members, for example in the form of much lower interest rates.  But this does not seem to be immediately in the cards.

The reaction that one hears from senior European officials and richer eurozone countries is that Greece (and Italy and others) should deal with their fiscal problems.  There is very little sympathy and even less bailout money.  This is in striking contrast with the attitude – and willingness to open pocket books – shown towards East-Central Europe, which is currently being treated more as a set of innocent bystanders.

It is hard to see how to pull a large global fiscal stimulus out of the hat.  Pursuing expansionary monetary policy in the US and elsewhere is much more likely to have first order effects on industrial countries and, through them, on the world’s economy.

Asking for a major push on fiscal policy is not a bad thing in most contexts.  But it does encourage free riding, i.e., you go build a lot of roads and bridges and I’ll recover through exporting vehicles and machinery to you – which appears to be the current German strategy.

Getting the G7 or G20 to really coordinate on fiscal stimulus is rather like OPEC trying to coordinate oil production cuts.  Both are really hard to do in a severe downturn, particularly as budget pressures mount.

Aside: my presentation was part of a panel discussion on the euro at the American Economic Association conferenc in San Francisco. ECB Vice President Lucas Papademos was also on the panel, and told the press afterwards: (I’m taking the quotes as reported by Citigroup this morning, to illustrate what the market is focussing on)…

inflation will not be allowed to fall significantly below 2% for a protracted period of time, over the medium term, which we do not expect on the basis of our present analysis”. He added, that the ECB “will do what is necessary, in terms of the timing and the size (of interest policy action) to ensure price stability”. However, he added that“cutting interest rates to very low levels must be judged with special care because of the long-term implications for price stability”

4 responses to “Eurozone Hard Pressed: 2% Fiscal Solution Deferred

  1. Pingback: The Long Bond Yield Also Rises « The Baseline Scenario

  2. The rest of the world would be better off long term to let the USD slide to where it truly belongs. This would bring near term economic pain, but longer term healthy realignment of purchasing power for countries that save, invest, and conduct sound fiscal and monetary policies.

    This ridiculous race to the currency bottom will rob global savers through inevitable inflation, which will take its biggest toll on the poor and middle class.

    Policy objectives should be to promote healthy, sustainable behavior. American, Greek, and Italian behaviors are not the example to which we should be holding the rest of the world!

  3. So if we assume the world economy needs 2% stimulus, and that economy is roughly US $70 trillion that implies $1.4 trillion of necessary stimulus. The US gov’t (in all its various forms) is now talking about $1 – $2 trillion in stimulus – mostly increased gov’t spending. In spite of this, markets do not seem to believe this will provide an adequate solution – as gauged by various global stock markets’ reactions so far.

    Therefore, I would argue this is a nice theory. But, the issue is not only how much is spent, but HOW it is spent. And so far, no one is quite sure how the money will be spent. My fear is it will be far too much in “pork barrel” projects and far too little in incentivizing future productive behavior and spending with true long term benefit.

    Not all spending is created equal.

    Not all spending is productive.

    Not all spending incentivizes productive growth…Witness the essentially useless US tax rebates of 2008 now burdening our children and their children…

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