Inflation warning over eurozone public spending
Eurozone governments will have to rein back public spending if they are to avoid “unacceptable” increases in inflation, a report warned today.
The report, entitled The Euro in Crisis, raised doubts over the survival of the single currency unless the 12 member-states can agree to centralise their tax and spending policies within the next few years.
And its author, economist Professor Tim Congdon, said that the euro’s governing Stability and Growth Pact must be tightened up to prevent prices soaring.
He proposed that the European Central Bank cut the maximum budget deficit permitted under the Pact from 3% to 2% of GDP, even though several leading eurozone economies – including France and Germany – have already failed to stick to the more generous limit.
Earlier this year, the eurozone leaders confirmed the 3% limit, and gave themselves a number of get-out clauses, allowing countries to avoid sanctions if they break the target in their efforts to spend their way out of economic problems.
In his report, published by the European Policy Forum, Prof Congdon hailed the ECB for doing a “superb” job in keeping eurozone inflation to 2% over the last six years.
But he said Europe’s leaders show “no sign of recognising the logic which justifies the case for fiscal prudence”.
Because the eurozone’s underlying growth has fallen from 3% to 1.5% a year, “it follows that the deficit-GDP ratio consistent with a 60% debt-GDP ratio in a steady state with 2% inflation is now not 3%, but about 2%,” he argued.
“The key message is that deliberate increases in budget deficits are likely either to raise debt interest costs by more than the increase in the budget deficit, or to increase inflation.
“Given that very low inflation is essential to the continued popularity of the euro, an economically unsustainable course of action must also – in the end - be politically dangerous and unacceptable.
“Fiscal centralisation within a fully-fledged political union is a precondition for success in a monetary union. Bu the necessary degree of fiscal centralisation will not occur in Europe for the next 20-30 years, and doubts have to be raised whether the eurozone can survive that long.
“Unless the eurozone’s leaders are able within the next few years to enforce genuine fiscal centralisation across the 12 member-states, a reasonable conjecture is that the UK fiscal arrangements will look increasingly satisfactory by comparison.”
