Obsolete Rules

1 December 2003


France and Germany Get a Pass on Budget Deficits

The sluggish economies of France and Germany have forced the EU to bend its rules, which say that budget deficits cannot exceed 3% of GDP. At a finance ministers' meeting, the two did not face disciplinary action for violating the rule for the third consecutive year, but rather undertook to get back below the 3% threshold in 2005. The EU Commission immediately started fussing and has threatened legal action. However, the deed is done, and the damage should finish the rule off. Good thing, too.

The arbitrary 3% threshold was set up as part of the Stability and Growth Pact that was established to bring Europe's economy's into some kind of harmony in preparation for the launch of the euro. The worry was that excessive deficits would spark inflation and other economic problems that would undermine the euro's value. Or so the eurocrats said. Another interpretation was that the adoption of these Germanic policy limits would entice the Germans to surrender their Deutschmark, which was already the European standard.

As 2003 ends, though, the euro experiment seems to have succeeded. It is worth more now in dollar terms than when it was launched. No one turns down payment in euros, even outside the eurozone. The worries about the euro are gone, but the worries about German and French economic growth continue. These reflationary deficits are needed; after all, what good is a stable currency in a depression?

The eurozone is now a single, federal, nation in economic terms; similar to the US, Canada and Australia. Economic growth and activity are not even spread in these places, nor will they ever be. The mess that California's budgetary irresponsibility has created for the US is a matter of grave concern to people in Texas, Florida and Minnesota. Europeans are right to worry about the same sort of thing happening there. However, the US would be far worse off if California's financial tools were constrained by some arbitrary deficit level, the purpose of which had already been realized.

It is true that the Stability and Growth Pact was designed to prevent a California style situation from arising in Europe in the first place. However, unemployment in both countries is painfully high, and growth in the third quarter was 0.2% in Germany and 0.4% in France. In the US, including the drag that is California, just reported its third quarter growth rate of 8.2% annualized. How much worse would things be in Europe if France and Germany kept to 3%?

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