- The Washington Times - Tuesday, October 22, 2002

Recent times have been quite eventful across the eurozone. Germany's difficult banking problems, which had been exacerbated by a record level of bankruptcies and the collapse of its stock market, seemed to worsen on the heels of rumors that Commerzbank faced a liquidity crisis after incurring substantial derivatives losses. Standard & Poor's slashed its credit rating and those of other major German banks. By last week's end, despite a rally, the stock price of Deutsche Bank, Germany's largest, was off nearly 30 percent over three months, while the share prices of other major German banks were down more than 40 percent over the same period.

As bad as they are, Germany's banking difficulties paled compared to its rapidly deteriorating fiscal situation. With a 9.8-percent unemployment rate translating into more than 4 million unemployed workers, Germany's welfare payments were soaring. Meanwhile, its tax revenues were plunging, a consequence of its dead-in-the-water economy, whose growth rate over the second half of 2002 is expected to slow sharply from its feeble annual rate of 1.1 percent for the first half. Germany also slashed its projected growth rate of 2.5 percent for 2003 to 1.5 percent.

As a result, the government of Germany, which had insisted that all prospective euro nations embrace the European Union's Stability and Growth Pact as the price of admission to the single-currency regime, announced last week that it would be in violation of the pact's terms this year. The combination of rising welfare payments and falling tax receipts means that Germany's budget deficit will exceed the 3 percent limit prescribed by the pact, the government finally acknowledged last week.

No sooner did Germany admit the obvious than European Commission President Romana Prodi declared from Paris in an interview published Thursday in Le Monde that the growth and stability pact was "stupid." Meanwhile, French teachers were demonstrating in Paris over expected job losses and funding cuts. France, too, is in danger of breaching the 3 percent budget-deficit limit. However, French President Jacques Chirac, whose economy will be lucky to grow by 1 percent this year, has made it clear that he has no intention of being fiscally hemmed in by the provisions of the growth and stability pact. Indeed, only last month, both France and Germany as well as Portugal, which was the first to breach the deficit limit, and Italy, whose budget standards have been compared to Enron's accounting methods forced the European Commission to extend the deadline for a balanced budget from 2004 to 2006.

Speaking of Italy, on Friday millions of workers from the nation's largest union engaged in a one-day strike that caused chaos throughout Italy's transportation system. The strike was called to protest the budget and labor-reform policies of Prime Minister Silvio Berlusconi. Over the past year, Italy's economy has grown a paltry 0.2 percent. Now, the long-embattled automaker Fiat, the nation's largest private employer, is seeking to shed 8,100 jobs, or 20 percent of its auto workforce in Italy, in a long-overdue retrenchment.

While the growth and stability pact has undeniably restricted the fiscal options of the eurozone's three largest economies this year, the European Central Bank (ECB) has adamantly refused to lower its base short-term interest rate, which remains at 3.25 percent. That's nearly double the Federal Reserve's federal-funds target rate, which stands at 1.75 percent. Notwithstanding the fact that Germany, by far Europe's largest economy and the continent's economic locomotive, is facing intensifying deflationary pressure, the ECB publicly frets about inflation.

It seems bizarre that the growth and stability pact seeks to force eurozone economies to adopt contractionary fiscal policies as they approach recession. The right short-term policy mix would be an easing of both monetary and fiscal policies. Over the long term, however, those policies will not produce the level of growth that an expanding European Union will desperately need. Labor markets must still be made far less rigid in the Big Three. Product markets will need to be exposed to more competition, not less. Growth-oriented fiscal policies (i.e., lower taxes) must be adopted. And the welfare states must jettison their routine acceptance of long-term unemployment rates between 8 percent and 10 percent.

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