Europe’s new fiscal compact treaty does not outlaw Keynesianism and is a stepping stone to more progress

by Jacob Funk Kirkegaard

Vox
February 6, 2012

Europe’s new fiscal compact is seen by some as the death of Keynesian government spending. This column argues that such analysis is simply wrong. It says that there is still room for government spending in extreme situations, but that there are now more safeguards to maintain stability, reduce contagion, and placate German taxpayers.

In record time since the idea was first mulled over at the EU Council on 9 December 2011, Europe has compiled a new Fiscal Compact Treaty. Angela Merkel on the night of its final approval on 30 January called it a “masterpiece”. It is perhaps unsurprising, though, that not everyone agrees. Many policymakers and economists – particularly those in English-speaking or peripheral European countries – have quickly dismissed the new Fiscal Compact Treaty as an economic disaster for Europe that, true to caricatures of German policies, forever outlaws Keynesian countercyclical policies.

However, for at least two reasons, it is wrong to simply condemn the new Treaty as the completely wrong answer.

First of all, when one actually reads the provisions of the new Treaty, it becomes clear that they do not in fact contain any budgetary constraints enshrining ‘pro-cyclical fiscal policies’ and even outlaw Keynesianism. Commentary like the recent archetypical editorial in the New York Times (2012) asserting that the Treaty “will legally restrict [European governments] from fighting recessions with robust fiscal stimulus” is simply wrong. Actually, Article 3 states that Eurozone members “may temporarily deviate from the medium-term objective [a structural budget deficit of 0.5% of GDP] or the adjustment path towards it only in exceptional circumstances.” The rules thus concern the ‘structural budget deficit’, not deficits driven by cyclical economic trends. This provision is thus not comparable to, for instance, the balanced-budget requirements in many US state constitutions, which have in recent years forced them to enact severe budget cuts, despite a weak US economy.

A structural budget deficit is defined in the Treaty as the “annual cyclically-adjusted general government budget balance net of one-off and temporary measures.” Contrary to the New York Times’ assertion, Eurozone governments can therefore implement a “robust fiscal stimulus” if it so needs.

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