June 26, 2001
Don't Blame Wim
Nothing focuses the mind like the prospect of hanging, according to the old saying. And while the gallows aren't being built just yet, Euroland's deteriorating economic situation is making quite a few
of those charged with overseeing European fiscal policy edgy.
So we weren't surprised when the latest raft of bad news about the euro zone's slowing growth and rising inflation prompted fresh calls from the German and French governments for an EU "economic
government" to match its single currency, the euro. An economic government is tax harmonization on steroids, designed to give Euroland a fiscal policy straitjacket and presumably make monetary policy easier to
manage across the 12-nation currency zone.
While we're sure that European Central Bank President Wim Duisenberg appreciates the concern over the challenges he faces, he's made it pretty clear that this is not the sort of help he needs. What he
could use, and has repeatedly called for, is serious reform of European labor markets and tax codes.
Mr. Duisenberg repeated his call again in a statement issued following the ECB's regular meeting last Thursday. In carefully chosen diplomatic language, he distinguished between "successful"
and "unsuccessful" fiscal policies in the euro zone, and suggested that structural reform to reduce labor-market rigidities and to lower taxes would enhance the growth potentials of the unsuccessful ones.
In case the message wasn't clear enough, Spain's deputy prime minister and economic minister, Rodrigo Rato, put in a clarifying word of his own in a recent interview. "The target of European
economic coordination should shift from too much emphasis on tax harmonization, which usually results in higher taxes, to a more advanced and ambitious program of supply-side economics," Mr. Rato said.
In other words, high taxes and labor-market rigidities are strangling economic growth in all but a few euro-zone countries. "Monetary policy should be aimed primarily at the stability of
prices," he added. That is, it is not Mr. Duisenberg's job to bail out the sclerotic economies of those countries still clinging to the social-welfare state.
It is impossible to serve two masters, or at least to serve them both well. Mr. Duisenberg has been blessed with an undivided mandate: maintain price stability. In particular, the ECB is charged with
keeping inflation under 2% annually for the euro zone as a whole.
This mandate should make the ECB's job simpler than that of the U.S. Federal Reserve, for example, which is charged with maintaining both full employment and price stability. But lately the ECB, which
meets today to discuss the direction of Euroland monetary policy, has been making its one job look harder than the Fed's two.
But the real villain here is not the ECB, it is those countries such as France and, when it comes to labor-market policy at least, Germany, that refuse to bow to the economic reality with which the
euro has confronted them. An economic government designed to protect those states most in need of reform will only exacerbate the situation. Europe needs more fiscal competition, not less.
Germany, ironically one of the proponents of harmonization, has already started down the right path by cutting marginal and corporate tax rates. It is possible that its present economic weakness is in
part the result of economic hesitation while companies and individual wait for the phased-in portions of the tax cuts, such as the elimination of the capital-gains tax for corporations, to take effect.
The U.S. Federal Reserve meets today and tomorrow, and is widely expected to announce a rate cut at the conclusion of that meeting. It will be the Fed's sixth cut in as many months. When the European
Central Bank met last Thursday, it left rates unchanged. When the year began, Euroland's short-term rate target stood at 4.75%; it is now at 4.5%. In the same period of time, the Fed has slashed the federal funds
rate to 4% from 6.5%. By Wednesday, it may be as low as 3.5%.
Against this backdrop, it is easy to claim that the ECB is being too tight with the money supply. For most of the last six months, the ECB has justified its policy on the grounds that the euro-zone
economy was in better shape than America's and that the ECB was fighting inflation.
But figures out of Germany late last week indicated the possibility of economic contraction in the second quarter. Coupled with declining sentiment in employer surveys, these numbers raise the specter
of recession in Germany. Meanwhile, euro-zone inflation has hit a nine-year high of 3%, well above the ECB's 2% target.
Put together, this implies that the euro zone is flirting with recession even as inflation creeps up toward uncomfortable levels. The price-level figures imply that, if anything, the ECB is playing it
a little fast and loose in keeping rates so low. Instead of making Mr. Duisenberg's job harder by trying to browbeat him into abandoning his inflation targets, Europe's fiscal chiefs should be taking his advice, and
that of their colleague Mr. Rato, and getting their own fiscal houses in order. That means cut taxes. That means making it easier for companies to both hire and fire. It does not mean creating an EU tax cartel.
Going down that road, the EU's finance ministers might forestall the trip to the end of the rope.
-- From The Wall Street Journal Europe