Pact still too rigid ‘to reap euro gains’

By Anna McLauchlin

Date: 03/02/05

The EU Stability and Growth Pact must be made more flexible if Europe is to feel the benefits of the single currency in the short term, senior UK economist Rosemary Radcliffe has warned. Radcliffe helped draw up an economic report published today (3 February) which shows that there has been little economic convergence between the eurozone member states since the single currency was formally adopted in 1999.

"The way in which the pact is specified is unhelpful," she said. "We have a single monetary policy which, because it has to fit everybody, may well end up not fitting anybody. And we have a fiscal regime which doesn't allow for fiscal policy to pick up where monetary policy is a blunt instrument."

It is vital, Radcliffe argues, that policymakers redefine the pact and allow governments leverage where budgetary deficits are concerned. The current pact prevents member states from exceeding a deficit of 3% of gross domestic product.

"Those numbers were based on arbitrary figures rather than real economics," she said.

More flexibility could help to offset the "short-term pain" currently being suffered by the euro area as it adjusts to the constraints of the single interest rate policy, she said.

Radcliffe presented the report, published today by PricewaterhouseCoopers (PwC), to the European Commission's economics department. According to the report, the one-size-fits-all interest rate for the euro area - currently set at 2% - is not allowing the eurozone to reach its full potential.

"[It] appears too tight for sluggish, low inflation economies such as Germany and the Netherlands, but too loose for faster-growing countries such as Spain, Ireland and Greece," it reads.

The report shows that, while growth rates in investment and net exports have converged slightly, since 1999 levels of consumption and investment spending are still showing wide divergences.

The larger euro countries are showing greater signs of convergence than smaller ones, but growth performances are still different between Spain and France on one hand, and Germany and Italy on the other, the report says.

"The fact that there has been no convergence is not necessarily a problem but there are some indications that there is some strain," said Radcliffe. Longer term - within five years - Europe should see the benefits of the single currency in the form of boosted cross-border trade and investment, she said, as long as monetary policy is reinforced by internal market policies. The report forecasts slightly more pessimistic growth forecasts for the euro area than those announced by the Commission in its autumn economic outlook. For 2005 PwC forecasts that the eurozone will grow by 1.75% while the Commission expects 2.0%. And it claims that the risks to growth are "weighted to the downside" due to sluggish domestic demand and currency risks. Radcliffe said that most economists had shaved a little off their expectations for the eurozone because of concerns about growth in the US and the rising value of the euro versus the dollar.

"Euro exporters are clearly going to have a tougher time in the global economy," she said.

A report presented to the European Commission's DG Economic and Monetary on 3 February 2005 states that there has been little economic convergence between the eurozone Member States since the single currency was formally adopted in 1999. The report argues for a more flexible Stability and Growth Pact.