Low inflation ‘essential’ for euro

Andrew Woodcock

Called ‘The Euro in Crisis’, it raised doubts over the survival of the single currency unless member-states can agree to centralise their tax and spending policies.

Its author, economist Tim Congdon, said that the euro’s Stability and Growth Pact must be tightened to prevent prices soaring.

He proposed the European Central Bank cut the maximum budget deficit permitted under the Pact from 3% to 2% of GDP. This despite eurozone economies like France and Germany failing to stick to the more generous limit.

Earlier this year, eurozone leaders gave themselves a number of get-out clauses, allowing countries to avoid sanctions if they bust the target in their efforts to spend their way out of economic problems.

In his report, Prof Congdon hailed the ECB for doing a “superb” job in keeping eurozone inflation to 2% over the last six years.

But he said Europe’s leaders show “no sign of recognising the logic which justifies the case for fiscal prudence.”

Because eurozone growth has fallen from 3% to 1.5% a year, “it follows that the deficit-GDP ratio consistent with a 60% debt-GDP ratio in a steady state with 2% inflation is now not 3%, but about 2%,” he argued.

“The key message is that deliberate increases in budget deficits are likely either to raise debt interest costs by more than the increase in the budget deficit, or to increase inflation.

“Given that very low inflation is essential to the continued popularity of the euro, an economically unsustainable course of action must also be politically dangerous and unacceptable.

“Fiscal centralisation within a fully-fledged political union is a precondition for success in a monetary union. But the necessary degree of this will not occur in Europe for the next 20-30 years, and doubts have to be raised whether the eurozone can survive that long,” he said.