Europe Renews Austerity Fight

A number of key voices are pushing for relaxed finances and slower structural shifts.

Copy-hungry journalists must love Europe. It seems to approach each phase of this ongoing crisis with wholly new solutions. For those who write on it, this evolution demands a series of new explanations and invites renewed speculations at each turn. But for investors and business people, it is less welcome. It makes planning next to impossible. And because planning is essential for financial stability and economic expansion, the continent’s economy and financial markets would benefit from something that is perhaps less exciting to write about—and more definite and predictable.

In this latest turn, eurozone members seem to have developed new doubts about fiscal austerity. A tenuous consensus had formed around the need for budget restraint and deficit reduction, but now some look to moderate the severity of the program, while others would reverse policy altogether. This new turn, disruptive as it is, does have virtues. It would, after all, lift the threat of a vicious downward economic cycle in which austerity depresses economic activity that causes worse deficits that only invite more austerity. But at the same time, the shift in fiscal emphasis carries its own ills. For one, it threatens to bring the continent back to its old profligate ways. Even worse, this new turn from austerity seems to have distracted policy makers from their former embrace of structural reforms and the promise they made to ease the continent’s fundamental fiscal-financial woes.

The austerity consensus never had complete support. French president Francois Hollande ran for office last year on a platform of fiscal relaxation. Because the preference for austerity was still dominant at the time, he glossed specifics enough to allow voters to see him simultaneously as both for and against austerity. But the signs were there. If Hollande signaled an early warning, the first major cracks in the austerity consensus became fully evident in Italy’s February election. The electorate there, enraged by the economy’s decline, returned an inconclusive vote that clearly threatened the fiscal and regulatory reforms set in motion by the outgoing prime minister, Mario Monti. For a while, Italy could not even form a government. When, recently, it did, the new prime minister, Enrico Letta, was clearly constrained. Though his Democratic Party had endorsed the previous fiscal program, he could only hold power by making concessions to the contrary positions of his powerful opposition.

Since then, policy fissures have grown even wider. Hollande has seized on the changing environment to climb off the fence he had made for himself. He has reneged on his a former promise to bring the budget deficit down to 3 percent of the nation’s gross domestic product (GDP) this year and now talks of a target closer to 4 percent. Spanish prime minister Mariano Rajoy, having endorsed rigid austerity for the entire sixteen months since his election, has recently outlined new policies that would allow less pressing deficit targets. Portugal has followed suit. In just the last couple of months, the Lisbon government has decided to pursue fiscal stimulus, including corporate tax cuts. It has promised to bring its budget deficit, presently at 6.4 percent of GDP, down to the promised 3 percent by 2015, but many question the prospect given the government’s new policy posture. Italy’s prime minister, Letta, though he recently announced in Berlin that he would continue ongoing budget rigor, had already softened policy, proposing, almost on taking office, to cut taxes on sales and property and widen Italy’s welfare net, including jobless benefits.

European Commission president José Manuel Barroso explained the change in tone. He told the media bluntly that austerity had “reached its limits,” having lost the public support it needed to work. He, too, now wants more latitude for countries to run deficits wider than 3 percent of GDP. Even the International Monetary Fund (IMF) has changed. Having long promoted strict budget discipline, in just the last month or so Managing Director Christine Lagard has begun to question the value of such a harsh policy. Also acknowledging the change is European Commission economic chief, Olli Rehn. He has embraced a “smoother pace to fiscal consolidation,” telling the United States and others arguing against austerity: “Can I tell you a secret? We have already slowed down fiscal consolidation.” Of course, Greece and Cyprus, desperate for aid from the rest of the eurozone and the IMF and bound by past agreements, continue austerity measures, but the cracks in the former consensus are apparent.