Growth Pact needs immediate reform
However, the reality is somewhat different. In economic terms, American GDP growth this year will probably be three times stronger than euro area GDP growth.
The dollar has remained weak in a post-war market because America’s monetary authorities want it to. While US Treasury officials continue to state that they want a strong-dollar, their actions speak louder than their words.
For example, Japan is actively intervening in the international currency markets in an attempt to weaken the yen against the US dollar. Japan wants a weaker yen, to increase demand for Japanese exports.
But if the yen is to weaken, then the dollar has to strengthen - and America is vociferously objecting to this.
If the US Treasury really wanted a stronger dollar, why would it object to a Japanese initiative that results in a stronger dollar?
In reality America (just like Japan) needs a weaker dollar to drive its economic recovery. A weaker dollar will result in increased demand for US goods and services, both in America and internationally.
But a weak dollar will result in a stronger euro. And that’s not going to help growth prospects in the Eurozone.
So if we can’t control exchange rates, what can be done to close the growth gap between the Eurozone and the US?
As usual, the answer lies in reform, and the most obvious target for immediate reform is the Stability and Growth Pact. Remember the Pact currently limits the spending of euro area member states, by stipulating that budget deficits must be kept below 3% of total GDP.
What this means is that member states which borrow and spend excessively in an attempt to reverse an economic downturn will eventually be penalised by the European Commission.
However, the Pact was not drafted with an economic downturn in mind. Yet that’s the situation we find ourselves in now.
And many have argued that the Pact should be amended in order to reflect this reality. Last week, these arguments may finally have been heeded.
It is widely expected that both Germany and France will post deficits in excess of 3% of their respective GDP’s this year. This should instantly result in a fine.
But European Monetary Affairs Commissioner Pedro Solbes was last week quoted as saying that Germany and France wouldn’t be automatically penalised if their deficits exceed 3%.
Could this comment herald a change? Could the Pact, for example, be amended to exclude spending on infrastructure from deficit calculations?
America’s budget deficit this year will likely exceed 5% of US GDP.
The Eurozone has to level the playing pitch if it is ever to compete with the US in growth terms.
An easing of the restrictions of the Stability and Growth Pact would be a step in the right direction.
Niall Dunne, Ulster Bank.
The views and opinions expressed in this article are those of the author and do not necessarily correspond with those of Ulster Bank or any other member of the RBS Group.
