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After austerity

15 October 2015 By Neil Unmack

The euro zone is rediscovering sloppy fiscal policy. Politics has taken precedence over prudence.

The club of fiscal rebels is growing steadily. The European Commission has warned Spain is on course to miss a budget deficit of 2.8 percent of GDP in 2016, due to its optimistic assumptions on growth. Ireland announced a 1.5 billion euro spending splurge next year. Italy plans to run a higher-than-expected deficit of 2.2 percent of GDP in 2016, despite faster-than-expected GDP growth.

The European Central Bank has helped prod the rollback by keeping borrowing cheap. The political cycle is also at work. Spain’s government is fighting both regional secessionists in Catalonia and the radical Podemos party in this year’s vote. In Italy, Matteo Renzi needs to keep Italians on side to back his referendum on political reform. The Irish government is keeping voters sweet for next year’s election.

The higher-than-expected deficits are not in themselves worrying. The deficits, ranging down from Spain’s expected 3.5 percent of GDP, are still low by historic standards. Besides, the euro zone recovery is still young, so governments have time to cut deficits more slowly.

What is worrying, or at least disappointing, is how the larger deficits are being used. There is relatively little support for long-term growth, through job-friendly tax cuts or infrastructure investments. Instead, governments seem keen to help voters’ immediate cashflow.

Spain is struggling with higher-than-expected social security costs, and also cutting income taxes. Italy, meanwhile, wants to lower property taxes, a move with little economic benefit. And economic reforms are slowing, particularly in Spain.

While some of the ex-crisis countries are pulling back austerity, Germany is piling it on, by trying to keep its budget balanced for the second year running. That is hard on the rebels, as weaker demand in the north slows growth in the south.

Pressure on the borrowers could diminish. The refugee crisis could bring Germany back into deficit and the emerging market slowdown could prompt greater sympathy there for additional fiscal stimulus. Largesse may yet keep the euro zone’s fiscal peace.

 

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