The election of François Hollande will not lead to dramatic changes in economic policy in France and Europe, comparable to what happened after the election of François Mitterand in 1981. Since the failure of the economic program agreed by the socialist and communist parties in 1983, all governments in France have agreed to respect the double external constraints imposed on them: the economic constraint that requires preserving firms’ competitiveness, and the political constraint that requires preserving the European Union’s “acquis” and the good relations with Germany.
This does not, however, prevent French governments to negotiate with their European partners, as was the case in June 1997 following the accession of the Socialists to power. At that time, the new Prime Minister, Lionel Jospin, and his Finance Minister, Dominique Strauss-Kahn, asked to renegotiate the Growth and Stability Pact that had been adopted by the European Council in Dublin in December 1996. This caused some tension, but in the end, the new French government agreed to support the Pact in exchange for advances in terms of economic policy coordination and social policies.
Clearly François Hollande would like to repeat this successful operation and obtain to complete the fiscal compact with growth-oriented measures. His explanations on what he intended to propose suggest he will not require a radical change of economic policies. While this might be good news for the Germans, financial markets might be disappointed given the current economic conditions in the eurozone. Erring on the side of caution might be as futile as the excess of ambition shown by Mitterand in 1981.
A growth compact to support aggregate demand and businesses
The economic downturn in the eurozone is worrisome not only because it is significant but also because governments seem powerless or unwilling to do anything to counteract the downturn. Fiscal policy is paralysed by the level of indebtedness and the commitments taken in the fiscal compact. Monetary policy has lost its effectiveness because of the fragility of many banks and the reorganisation of their funding within each country’s national borders. Structural policies generate positive results only in the medium and long term. In these circumstances, the only hope of a recovery relies on the positive impact of austerity and reforms on market confidence and interest rates.
One is entitled to raise doubt about the speed at which confidence will come back. It would therefore be prudent for the eurozone leaders to react by adopting a strategy that would stimulate aggregate demand and strengthen companies’ competitiveness. The following measures could be an integral part of this strategy.
- Automatic stabilizers: Eurozone governments should agree to stop taking new austerity measures in 2011 and define next year’s budgetary consolidation in terms of structural measures (for instance 0.5% of PIB) and not in terms of specific reduction in deficit and debt ratio.
- Monetary supply: The European Central Bank (ECB) should find ways to repair the process of monetary creation. The current annual growth rate of M3 (2.8% in February) is too low compared to the implicit target guiding ECB monetary policy (4.5%). If the ECB believes that the transmission of monetary policy could only be improved if the banking system is recapitalized, it should state it publicly to convince governments to address this problem quickly, possibly by allowing the European Financial Stability Facility (EFCF) to take stakes in banks.
- Targeted investment: Eurozone governments should also launch a program of investment to strengthen the competitiveness of the economies of Southern Europe and reduce the degree of wage reductions that is required to allow these economies to compete globally.
The adoption of a growth compact would not mean, of course, that fiscal discipline should be abandoned. To avoid any ambiguity, the eurozone governments should reiterate their commitment to ratify the Fiscal Treaty quickly. They should also undertake to update their stability programs to present the structural reforms they will implement to get them back to balanced budgets.
A debate on a new treaty on fiscal integration
Investor and business confidence would return faster if the eurozone governments would agree to further reduce the vulnerability of the eurozone to contagion. There are two serious solutions to achieve this objective: the adoption of Eurobonds and the granting of a banking license to the European Stability Mechanism to allow the ESM to refinance itself from the ECB.
It is unlikely that the German government would agree to support this type of solution without having previously obtained a strengthening of the governance of the eurozone. Indeed, these solutions mean authorizing a European agency to borrow large amounts of money from the capital markets or the ECB, under joint and several liability, to reduce the borrowing cost for eurozone countries at all times or only during periods of tension in sovereign debt markets. As joint issuance would substantially raise the liabilities of Germany, any such plan would have to be matched by new rules so as to avoid a situation whereby one country would not comply with the provisions of the Fiscal Pact, thereby forcing the other countries to assume a higher debt burden.
Against this background, it would be good if the new French President would propose to launch a discussion on the institutional arrangements that would be necessary to create new financial solidarity mechanisms between eurozone members. It is to be hoped that he will not be afraid to take such an initiative because it could lead to some transfer of sovereignty. This would be even more regrettable given that Chancellor Merkel has recognized earlier this year that she was open to the idea of Eurobonds in the longer term, at the conclusion of a process of deeper economic and political integration.