It looks unlikely that Italy’s new populist government will seek confrontation with Brussels about its budget for 2019 after all. Although, the threat of an excessive deficit procedure that could culminate in a fine worth 0.5% of GDP is probably not what tipped the balance. It is more plausible that they have developed a healthy respect for the influence of the bond market.
The ten-year yield differential between Italy and Germany has risen more than 150 basis points since the radical 5-Star/League came into power. Budgetary developments in the US would tempt observers to conclude that the once-famous ‘bond vigilantes’ have been in a state of induced coma, but in the case of Italy they appear to be alive and kicking.
Mobilizing financial markets against a member state can force it into a budgetary straightjacket, imposing a modest fine cannot. Such a fine has to framed in terms of billions to disguise the fact that in economic terms what it actually boils down to is peanuts.
Modest fines which offer little incentive are not limited to EU budget rules. Fortunately, European leaders are aware that macroeconomics involves more than just fussing about sovereign debt, budget deficits and the overriding importance of price stability. One of the few good things to come out of the Great Depression is the introduction of the Macroeconomic Imbalance Procedure, a surveillance mechanism that can also result in a fine – in this case of a negligible 0.1% of GDP.
The aim of the procedure is to identify potential macroeconomic imbalances early on, and this year the only country deemed to be without imbalances was Slovenia. It was also noted that the current account surplus of the Eurozone was rising rapidly and is set to reach 3% of GDP in 2019. A lack of aggregate demand is one of the causes.
Well, we don’t have to worry that Italy will boost aggregate demand. What about virtuous Germany and the Netherlands? One of the most striking macroeconomic imbalances involves underinvestment in Germany, in both the public sector (try taking a train to or from Berlin) and the private sector. Over the past three years, frugality in both countries has led to an average current account surplus of more than 8%.
The threshold is strangely asymmetric (+6% GDP and -4% GDP), which suggests a bias towards a greater tolerance for such surpluses. This, what I believe to be, already excessive 6% threshold was determined on the basis of Germany’s average GDP (just below 6%) in the three years before the procedure was introduced. It is ironic that the European Commission speak of an “imbalance” for both countries, rather than an “excessive imbalance”.
Can countries can live with surpluses forever? In the years before Bretton Woods, John Maynard Keynes observed that surplus countries are not forced to reverse their situation and deficit countries cannot be financed forever. Therefore, his proposal to rebalance the world economy was to introduce a tax for countries that run current account surpluses. But he was thinking more along the lines of confiscating overdrafts than imposing a paltry fine of 0.1% GDP.
There is no chance that EU leaders will make their sanctions for such imbalances much heavier. The financial markets won’t be of much help either. The Eurozone will continue to display a dangerous deflationary bias.
This column was previously published in Robeco Quarterly magazine, September 2018