Budgetary side effects

Two of the euro zone's leading countries, France and Italy, have entered into the vortex of budget cutbacks, to make their deficits manageable and also, in the case of the latter, to respond to the threat of rising risk premiums. The cases are not similar. France, with total public indebtedness amounting to 84 percent of GDP, will this month enact a set of measures to address the deficit objective, even though its economy registered a disturbing deceleration in the second quarter. Italy, with a debt that exceeds 120 percent of GDP, has enacted a new budget adjustment, additional to that of July, of more than 45 billion euros. It comes as no surprise that Silvio Berlusconi's "heart bleeds" in announcing the plan. It includes a tax hike for higher incomes, the suppression of some municipal and provincial governments, and additional cutbacks in ministerial expenditure.

Though the cases are different (more serious is the case of Italy, whose economy has not grown in the last 10 years), the two cutback programs, plus that announced by Portugal (a sharp hike in VAT, with a heavily adverse effect on private incomes), an additional one to be unveiled next week by Spain, and those already being undergone by Ireland and Greece, all serve to paint a broadly similar panorama, in which approximately 50 percent of the European budget is now subject to important restrictions on expenditure. The immediate effect is to abolish all possibilities of implementing any stimulus to demand throughout almost all of Europe, while private incomes will suffer a reduction which, in the short term, limits any recovery in consumption. And all this in exchange for measures of only doubtful efficacy, at least in the case of Italy.

This series of budget and income adjustments (necessary to maintain the monetary stability of the euro zone) may precipitate the European economy into a new cycle of contraction. In spite of the painful cutback measures, sovereign debts are not falling in the short term, and the rate of saving is not increasing fast enough to finance national expenditure. The policies applied are contradictory. Extreme fiscal contraction coexists with low interest rates (not as low as those of the United States, while the European Central Bank (ECB) has decided to raise them) and with banks still incapable of normalizing the flow of credit.

In this labyrinthine landscape, the first piece in the puzzle must be placed by the ECB. It must renounce its strategy of raising interest rates; if anything, it ought to lower them. Merkel and Sarkozy must explain to the EU countries what policies they ought to implement, to combine budgetary rigor with some stimulus to growth. If GDPs stagnate or decline, the financial solvency maintained at the cost of public spending cutbacks will also collapse. Perhaps the answer lies in a reform of the markets, or in greater fiscal unity. But some response is needed. The strategy of ongoing budget adjustments throughout almost all of the EU territory is not producing the desired effects.