THE IDEA OF EURO-PARALYSIS IS AN ILLUSION / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( HIGHLY RECOMMENDED READING )

The idea of Euro-paralysis is an illusion

By Jürgen Stark

Published: August 15 2010 19:41

The financial crisis has shaken the global economy to its core. It has exposed the fragility of the foundations of private finance: opaqueness, hazard and sometimes fraud. The crisis has also revealed the weaknesses of public finance, both in the euro area and in other industrialised countries. In the euro area it has proved to be a watershed for collective reflection. It has spurred self-reform.

The success of monetary union is measurable by many yardsticks. Since 1999, average inflation has indeed remained anchored at the European Central Bank’s definition of price stability. Price stability has not come at the cost of higher real volatility, or lower growth. Over the period from 1999 to 2009, real per capita incomes in the euro area rose steadily at the same rate [1.2 per cent per annum] as in the US or the UK. Job creation became consistently more robust over the same period. Finally, the eurozone as a whole does not display any degree of external imbalance.

However, years of macroeconomic stability and economic progress may have inspired complacency. Not unlike the “search for yield” that has undermined private finance, low interest rates may have encouraged more public borrowing. Macroeconomic reforms were delayed in most of the European Union. In some countries, fiscal myopia was concealed by impenetrable accounting practices. Fragile public finances proved vulnerable to derailment when the crisis finally hit – and they did derail.

What lessons can be learnt? Two conclusions have gained increasing recognition in the last few months.

The first is that Europe faces a dilemma: either there is no political will to correct unsustainable fiscal developments or – if there is – synchronised fiscal adjustment will prove prohibitively costly for the eurozone as a whole.

The second is that we have witnessed some “Euro-paralysis”: the crisis has been an acid test for European institutions, and they did not pass the test because of policy inaction.

I dispute both of these conclusions and I will explain why.

The notion of a “European dilemma” confuses fiscal restraint with fiscal reform. In this respect, what is critical is that the fiscal policy correction not be an isolated act but rather a fundamental change in the underlying fiscal policy strategy – the policy strategy for realising primary surpluses now and in the future. While temporary fiscal adjustment curbs demand, changing the fiscal policy strategy can bring more revenue and more growth.

Such a change in strategy is happening today in those eurozone countries that have been caught up in the tailspin of the crisis.

The necessary adjustments that are being made are structural in character. Tax systems are being adjusted, and the structure and level of expenditure is being made more conducive to growth.

These adjustments increase the growth potential, and a higher potential makes nations wealthier. The European dilemma is an illusion: fiscal reform, if credible, can cut deficits and boost growth.

The idea of Euro-paralysis is another illusion. In the midst of the crisis, Europeans did not hesitate to act and to embrace reform. There is no shortage of evidence of swift and decisive action over the past years emanating from the major European institutions.

And there is a clear mandate for the Task Force on Economic Governance, established by the European Council and chaired by President Herman Van Rompuy, to push forward with reforms. We will see an enhancement of fiscal surveillance, a more stringent implementation of multilateral surveillance to correct excessive deficits and debt, and better instruments for the prevention and resolution of crises.

This combination of measures is of crucial importance. Reinforced fiscal surveillance is necessary, but not enough on its own: seemingly sound public budgets can simply reflect an overheated economy. So a new framework for macroeconomic surveillance will monitor whether national trends are compatible with those that are appropriate for the Union as a whole. This framework will allow both targeted peer pressure and differentiated and more binding recommendations on follow-up action at the national level.

The ambitious task that now lies before Europe is not only a visionary agenda. As I write, it is being pursued with determination, with the same sense of purpose that marked the further development of the European Coal and Steel Community into the EU, by setting realistic objectives and firm deadlines, and by mobilising the necessary political will within the national parliaments. Over and beyond any illusions, this is the reality of Europe today.

The writer is a member of the executive board of the European Central Bank

Copyright The Financial Times Limited 2010.