Deficit focus questioned as answer to euro crisis

DAVID McHUGH

Published: Saturday, Jan. 28 2012 4:35 a.m. MST

An illustration of a euro coin is displayed on a bank's advertising billboard as a man stands outside the branch in Athens, on Thursday, Jan. 26, 2012. Europe is getting tough on government debt. After more than two years struggling to rescue financially shaky governments, leaders of the 17 countries that use the euro are putting the finishing touches on a treaty that will force member countries to put tough deficit restrictions into their national laws.

Thanassis Stavrakis, Associated Press

FRANKFURT, Germany — Europe is getting tougher on government debt. After more than two years struggling to rescue financially shaky governments, leaders of the 17 countries that use the euro are ready to agree on a treaty that will force member countries to put deficit limits into their national laws.

At first glance, it seems logical — after all, the crisis erupted after too many governments spent and borrowed too much for too long.

But a number of economists — and some politicians — say the focus on cutting deficits is misplaced and that more fundamental problems are being left unaddressed.

It's how the euro was set up in the first place, they say — one currency, but multiple government budgets, economies moving at different speeds and no central treasury or borrowing authority to back them up.

Until those institutional flaws are tackled, the economists say, the euro will remain vulnerable. So far, Greece, Ireland and Portugal have turned to other eurozone governments and the International Monetary Fund for emergency funds to avoid defaulting on their debts.

Nonetheless, European leaders are pushing a new anti-debt treaty as the leading edge of their effort to reassure markets. European Union leaders hope to agree on the treaty's text at a meeting starting Monday, and sign it by March.

The proposed treaty pushes countries to limit "structural" deficits — shortfalls not caused by ups and downs of the business cycle — to a tight 0.5 percent of gross domestic product or face a fine. That comes on top of other recent EU legislation intended to tighten observance of the eurozone's limits: overall deficits of 3 percent of GDP and national debt of 60 percent of GDP.

European leaders are also urging countries to improve growth by reducing regulation and other barriers to business.

Yet economists like Jean Pisani-Ferry, director of the Bruegel think tank in Brussels, says it's striking that governments are focusing on budget rules, given Europe's earlier experience with them. An earlier set of rules were largely ignored at the behest of France and Germany in the first years after the euro's 1999 launch.

And some of the countries that now are in the deepest trouble — such as Spain and bailed-out Ireland — stayed well within the debt limit for years.

"This suggests that the simplistic view — that a thorough enforcement of the rules would have prevented the crisis — should be treated with caution," Pisani-Ferry wrote in a recent article for Bruegel.

Some European politicians are also voicing doubts about focusing primarily on deficits. They include new Italian Prime Minister Mario Monti, who has warned that growth is the real answer to shrinking debt in the long term. International Monetary Fund head Christine Lagarde has urged a broader approach. She calls for a willingness to share the burden of supporting banks and other financial risks so troubles in one country don't become a crisis for the entire currency bloc.

Here are four reasons for concern cited by economists — but not yet on the summit agendas of the eurozone's leaders.

NO COMMON BORROWING: Without a central, pan-European treasury, there's no steady central source of support for eurozone countries that run into economic or financial trouble. Many economists say issuing jointly guaranteed "eurobonds" would make sure no one country would ever default and governments would always be able to borrow. Governments would give up some of their sovereignty, allowing review of their spending and borrowing plans, to get the money.

Pisani-Ferry argues that this would protect governments from the kind of self-fulfilling bond market panic fueled by fears of default, that pushed Greece, Ireland and Portugal over the edge.

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