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Given that the ECB has – rightly – made intervention to ease monetary conditions in the peripheral countries conditional on those countries adopting a fiscal adjustment programme, the ball is in the court of the peripheral governments. Delaying the request of a programme, on grounds of political pride, ultimately increases the cost for the domestic economy.
On the other hand, it is not clear why countries which have already adopted a programme, like Ireland and Portugal, and are on track, should not benefit from a more accommodative monetary policy. The argument against the ECB buying the bonds of Ireland and Portugal is that these countries’ governments are currently out of the market and do not need such action. However, as long as the spreads on government bonds remain as high as they currently are in those countries, the private sector will not be able to borrow at lower rates. The transmission of monetary policy, which ultimately depends on the private sector’s access to credit, will remain impaired. And the economy will continue to suffer, making the fiscal adjustment last longer and be more painful.
Even if there is little scope for changing the overall size of the budget envelope in the different countries, there may be grounds for modifying the composition of revenues and expenditures in national budgets countries, with a view to foster growth and reduce imbalances within the eurozone. For instance, countries which already record an external surplus – like Germany – should aim at reducing taxation on consumption (known as sales taxes in the US or VAT in England) and compensate the lower proceeds from taxes on consumption with a rise in personal income tax or in social security contributions. The opposite should be done by countries – like Italy or Spain – which still record an external deficit and need to restore competitiveness.
The above mentioned symmetrical adjustment would be budget neutral and lead to a reduction in imbalances within the euro area and stimulate overall demand. It would improve market sentiment and facilitate the task of monetary policy.
Such a policy requires strong cooperation between the fiscal policies of the Member States. How can this be achieved? One way could be to use the new budget oversight procedures being developed in response to the crisis at the European level to assess the compatibility between the country-level budgets and the overall eurozone position. The initiative to do so is in the hands of the European Commission. Without such coordination individual Member States’ fiscal policies cannot take into account the impact on each other. They are thus bound to be overly restrictive and further broaden imbalances.