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April 5th 2005

EU fights to contain government spending

At a summit last week, EU members spent much time mooting the current rule which prohibits nations from running large budget deficits. The rule officially caps spending at 3% of GDP, and threatens violators with large fines. However, the rule has been completely ignored by many member nations, with France and Germany as the most egregious offenders. (None has even received so much as a public rebuke.) The two nations justified their deficits with the claim that the entire EU benefited from their respective spending on defense and R & D.

The European Union is completely unique, in that member nations are free to pursue independent fiscal policies, while they must all adhere to a common monetary policy. This can cause problems, as international lending rates should be correlated with government debt, and the risk of default. The implication here is that all member nations borrow money at the same rate, regardless of disparities in creditworthiness. Ostensibly, Italy could run a deficit equivalent to 20% of GDP without being forced to compensate lenders with a higher interest rate. The EU must soon reconcile this discrepancy, if it wishes to maintain any degree of monetary stability. The Economist reports:

The ECB hinted that it might respond to a new bout of fiscal incontinence in the euro area with higher interest rates. It still subscribes to the logic underlying the stability pact: that a single-currency area without a single government needs strong and enforceable rules to contain national budget deficits.

Read More: Debasing the Currency

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Posted by Adam Kritzer | in Euro | No Comments »

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