Security, Refugees and European Fiscal Policy

The EU is warning that Austria, Italy, and Lithuania are at risk of not achieving their 2016 budget goals.    It also warned Spain that is too may miss its target.  Nevertheless, the EU said there were no serious violations.

At the same time, the EU will exempt proven refugee spending from the budget scorecard.  In light of the attack on Paris, the EU's fiscal discipline faces a new challenge.  French President Hollande is arguing that the security pact trumps the stability pact.  France is at war, and the Lisbon Treaty requires its EU allies are obligated to help.

France had already had received special dispensation of its fiscal excesses.  Under the agreement, France was supposed to achieve a 3.4% budget deficit in 2016 and 3.3% in 2017.  However, these fiscal targets have been effectively jettisoned.  The increased security spending may see the deficit move in the opposite direction.  The French deficit this year was expected to be near 3.9% of GDP, assuming GDP itself expands by 1.1%.   France may not reach the 3% threshold this decade.

Structural deficits, which are essentially the fiscal shortfall if the economy was expanding at a trend pace, are supposed to be capped at 0.5% of GDP.  The vast majority of eurozone members have structural deficits more than twice the prescribed amount.  No fines have been levied or assistance denied.

The take away is that fiscal policy in Europe will likely be easier than thought a week ago.  Some critics of the EU argue that it is insisting on fiscal masochism, the fact of the matter is that the EU has been fairly lenient and more so than is often recognized.  Seven eurozone members are operating under the excessive deficit procedures (Cyprus, Portugal, Slovenia, France, Ireland, Greece and Spain), but they are not being forced into brutal tightening.  Nor are the fourteen countries with debts in excess of 60% being required to reduce the excess by 5% a year as has been agreed.

The euro area's slow growth, double digit unemployment, and no inflation threat do not cry out for fiscal austerity.  And the EU is hardly enforcing the Stability and Growth Pact and the supplemental agreements (dubbed the two-pack and the six-pack).   The EU is not being remiss.  From the crisis, the EU has required countries to sacrifice some sovereignty on fiscal issues.

The EU gets to review preliminary budget drafts.   It has pushed back on occasion, and it has also granted forbearance.  Portugal, which is still in the middle of its own political crisis, has not submitted a budget.   Spain is coming under very mild pressure, as Prime Minister Rajoy goes to the polls next month.

Traditionally, the best policy for a currency is tight monetary and loose fiscal policy.  This was the Reagan-Volcker policy mix and in Germany after the Berlin Wall fell.  The opposite is also true.  The worst policy mix for a currency is loose monetary and tight fiscal policy.  The eurozone is flirting with this combination, even if the region's fiscal straitjacket is not being enforced rigorously.  This is part the case for a weaker euro in the quarters ahead.