Eurozone

The eurozone countries collectively did far too much fiscal adjustment in 2011, 2012, and 2013. Germany joined in the consolidation in 2012, hurting the eurozone—and the world.

G-3 exchange rate moves over the past four years have had expected impacts on trade flows

Fiscally Driven Rebalancing Turns Out to Be Hard

The world would be in a better place today if the ECB and BoJ had joined the Fed in quantitative easing early on. Their lag in easing contributed to the policy gap that led to the dollar's large 2014 appreciation.

The idea behind “fiscally-driven external rebalancing” is straightforward. If countries with external (e.g. trade) surpluses run expansionary fiscal policies, they will raise their own level of demand and increase their imports. More expansionary fiscal policies would generally lead to tighter monetary policies, which also would raise the value of their currencies. And if countries with external (trade) deficits run tighter fiscal policy, they will restrain their own demand growth and thus limit imports. Firms in the countries with tighter fiscal policies and less demand will start to look to export to countries with looser fiscal policies and more demand. This logic fits well with IMF orthodoxy: the IMF generally finds that fiscal policy has a significant impact on the external balance, unlike trade policy.* But it often encounters opposition, as it implies that the fiscal policy that is right for one country can be wrong for another. Many Germans, for example, think they need to run fiscal surpluses to set a good example for their neighbors. Yet the logic of using fiscal policy to drive external trade adjustment runs in the opposite direction. To bring its trade surplus down, Germany would need to run a looser fiscal policy. The positive impact of such policies on demand in Germany (and other the surplus countries) would spillover to the global economy and allow countries with external deficits to tighten their fiscal policies without creating a broader shortfall of demand that slows growth. So one implication of using fiscal policy to drive trade rebalancing is that there is no single fiscal policy target (or fiscal policy direction) that works for all countries. Budget balance for example isn’t always the right goal of national fiscal policy. Some countries need to run fiscal deficits to help bring their external surpluses down. That idea certainly encounters resistance. And as practical matter, the IMF’s latest estimates show that Europe hasn’t used fiscal policy to help facilitate its own internal adjustment.** The big external surpluses in the eurozone are in the Netherlands and Germany. Germany and the Netherlands also have a lot of fiscal space thanks to relatively low levels of public debt, and could safely run expansionary fiscal policies without calling their own fiscal solvency into question. And the countries with lots of external debt and limited fiscal space tend to be further to the south: Italy and Spain for example (I am over generalizing a bit here—Spain has more external debt than Italy and a bigger fiscal deficit, while Italy has a bigger public debt stock and less growth).*** The eurozone also runs a significant overall external surplus, has internal economic slack and has low interest rates—it could help bring global trade into better balance (and raise the global return on saving) with a more expansionary overall fiscal policy while also bringing its own economy closer to full employment. Win-win, at least in theory. In practice, though, the eurozone didn’t run an expansionary overall fiscal policy last year. The change in the structural fiscal balance was positive, but only just.*** And the fiscal contraction in Europe last year came from the external surplus countries: the Netherlands notably. Not from the former external deficit countries. Fiscal expansions in Italy and Spain provided the offset that prevented the consolidation in the Netherlands from giving rise to an overall consolidation in the eurozone. The pattern of fiscal consolidation in the eurozone is a bit different than what the IMF recommended. The IMF wanted fiscal expansion in the Netherlands, and fiscal consolidation in Spain, Italy, and others (generally at a pace of about 0.5 percent of GDP a year)—more or less the opposite of what happened. And what of Germany? Well, the IMF thought a year ago that Germany was doing a fiscal expansion—one that would bring its fiscal surplus down from about one percent of GDP (see paragraph 9 of the staff report, and the table on German general government operations on p. 8). But it turns out there wasn’t much of a structural fiscal expansion in Germany last year. The structural fiscal balance stayed in a substantial surplus. That’s the problem. It turns out surplus countries seem to like surpluses. They often aren’t willing to take policy action to expand demand. And the since the output of the eurozone's traditional deficit countries is generally constrained by weak demand, they tend to want to run more expansionary policies to boost their economies. The same basic point applies globally. For fiscal policy to drive global demand rebalancing, the external surplus countries around the world need to run more expansionary policies. That means the eurozone, Korea, and Japan, among others, should adapt more expansionary policies (along with Sweden, Switzerland, and Singapore). And of course the U.S. would need to adopt a more contractionary fiscal policy, one aimed at bringing the U.S. current account deficit down. But there isn’t much sign in the IMF’s data for 2016 that the surplus countries are willing to do meaningful fiscal expansions (and as I noted last year, in many cases the IMF hasn’t been willing to advocate fiscal expansions in its fiscal advice to major surplus countries). Korea’s structural surplus remains big (the IMF looks at a measure of the fiscal balance that includes the surplus in Korea’s social security system, which offsets the headline deficit) and didn’t change much in 2016. The latest WEO data suggests a (very) modest structural fiscal tightening in 2016, with more tightening in 2017. Japan has an ongoing structural fiscal deficit—its current account surplus comes from high corporate savings, not a tight fiscal policy. It has slowed the pace of consolidation from 2014 (thankfully) but its structural balance does't suggest that is doing much to support demand. It continues to rely heavily on net exports to support its growth. And, as for the United States…well, the President wants a big deficit-funded tax cut. **** *The IMF recognized in its 2016 external sector report that fiscal policy should play a role supporting balance of payments adjustment in many (but not all) “surplus” economies. See paragraph 28: “Countries facing stronger-than-warranted external positions and negative output gaps should primarily rely on fiscal policy to help close both domestic and external gaps, although the stimulus should be geared to support structural reform objectives. However, reliance on fiscal support depends very much on the availability of buffers. Korea, Sweden, Thailand, and the Netherlands appear to have room to ease in relative terms. Other countries, like Japan, where current fiscal space is more limited, will need to coordinate carefully the use of monetary and fiscal space with structural and income policies. Meanwhile, in the few cases where positive external gaps are paired with near zero or positive output gaps (Malaysia, Germany), monetary policy, if available as an independent instrument, should play a larger role (Malaysia). Those economies without independent monetary policy but with fiscal policy space (Germany), should use that space to finance growth-friendly policies that would support external rebalancing (including through an internal appreciation) with only a temporary and limited effect on the output gap." ** For the charts, Cole Frank and I used changes in the cyclically adjusted structural fiscal balance, as reported in the the IMF's latest WEO data base. There is an argument that the structural fiscal balance isn't the right measure, as interest expenditure has fallen (though you can debate this—interest paid domestically should support some spending), and the right measures for the fiscal impulse is the change in the cyclically adjusted primary fiscal balance. The IMF doesn't report that though (it reports the primary balance, but not the cyclically adjusted primary balance). Eyeballing the numbers, though, doesn't suggest this matters much, with the potential exception of Japan (where the debt really is held domestically). For Spain in 2012, I did use the change in the cyclically adjusted IMF primary balance as reported in the 2014 IMF article IV—as the structural balance includes the bank recapitalization bill (the "official" number implied a consolidation of around 4 percent of GDP). More generally, it should be noted these numbers are estimates, not the word of god. The 2016 numbers likely will be revised. *** Some additional throat clearing. The eurozone used to have an internal version of the world’s balance of payments imbalances. Some countries ran big surpluses, others ran big deficits. By and large, those deficits have disappeared, while the surpluses stayed big—hence the rise in the eurozone's surplus with the world. But the large deficits left behind a large stock of external debt (notably in Greece, Portugal, and Spain), and the fall in the deficit left many parts of the eurozone short demand. So an imbalances problem inside the eurozone turned into a demand problem inside Europe, and, without the deficits in the “south” the eurozone started running large external surpluses and exporting its savings to the world. **** U.S. Treasury Secretary Mnuchin has embraced the argument that fiscal reflation in the surplus countries can help address global balance of payments imbalances. I agree. But it is kind of hard to square that argument with the Trump Administration’s deficit raising tax proposals.

   

The Wall Street Journal, building on a point made by Peterson’s Jacob Kirkegaard, seems convinced that the policy mood has shifted, and Europe is now poised to use fiscal policy to support its recovery. I, of course, would welcome such a shift. The eurozone runs an external surplus, is operating below potential (in large part because of a premature turn to austerity in 2010 that led to a double-dip recession) and in aggregate has ample fiscal space. And the public policy case for such a fiscal turn keeps getting stonger. Jan in ’t Veld’s new paper (hat tip Paul Hannon of the WSJ) suggests that a sustained fiscal expansion in Germany and the Netherlands could have a substantial impact on the rest of the eurozone. A sustained 1 percent of GDP increase in public investment in Germany and the Netherlands helps raise output and lower debt in their eurozone partners.* in ’t Veld writes: "Spillovers to the rest of the eurozone are significant ... GDP in the rest of the eurozone is around 0.5% higher." But it seems a bit too early to break out the champagne. Actual 2017 fiscal policy has not been set in the key countries, but it is not clear to me that the sum of the fiscal decisions of the main eurozone countries will result in a significant fiscal expansion across the eurozone. Indeed, I cannot even rule out a small net consolidation. Germany has put forward its 2017 budget. Schauble’s rhetoric has changed a bit. But Citibank estimates that it only would reduce Germany’s structural fiscal surplus by about 0.1 percent of GDP (10 basis points of GDP). It is a step in right direction, but only a baby step. Real loosening doesn’t seem on the cards before 2018. I do not think the Dutch have put forward their 2017 budget. But their 2016 stability report suggests that they are aiming for a structural fiscal consolidation of about 0.3 percent of GDP. They still want to bring their structural deficit down to around one percent of GDP. The French would likely need to do a bit of consolidation if they still intend to get their 2017 fiscal deficit under 3 percent of GDP, but I will grant that Hollande is likely to get a bit of flexibility heading into the election. Renzi would certainly like to provide a fiscal jolt to Italy’s economy. But the pressure on the Italians from the Commission and others is still to consolidate. Rules and all. The Commission’s target for Italy’s fiscal deficit in 2017 is 1.8% of GDP. I doubt Italy will do the consolidation that would be required to get the deficit under 2 percent of GDP, but I also am not convinced that Italy will be given space to loosen. The battle lines have been drawn up, but the actual battle has not yet been fought. If the impact of the Dutch consolidation is offset by the modest German expansion, and if France and Italy end up with a fiscal stance that is roughly unchanged, Spain becomes the wild card that could determine the eurozone’s overall fiscal stance. And, well, there seems to be a risk that in the absence of government, Spain’s spending will be held constant in nominal terms – resulting in a meaningful consolidation. HSBC’s Fabio Balboni: “If the 2017 budget cannot be approved by the end of the year, all of the main spending items will be frozen at current levels, including wages and pensions. That would be equal to spending cuts of about 1% of GDP. This might help to reduce the deficit, but it would also have negative consequences for growth.” Even if Spain forms a government that avoids sequester style cuts, it will face pressure to bring its deficit down. Daniele Antonucci of Morgan Stanley: “Spain will tighten the belt ... the question mark is to what degree, and that also depends on the political situation.” Bottom line: If Spain – which has the largest deficit of any of the eurozone’s main economies – ends up doing a significant consolidation, whether as a result of the absence of a government or as a result of a conscious decision by the Europeans to push Spain to move closer to its targets after it elects a new government, someone else has to do an actual expansion to keep the eurozone’s overall fiscal stance neutral. Best I can tell, Germany 2017 budget won’t do the trick. And until the 2017 budgets for France and Italy get approved, we won’t know if they will be able to offset a likely tightening in Spain. * Jan in ’t Veld’s paper assumes the fiscal stimulus is not offset by monetary policy in the first two years, and the euro initially depreciates. His argument is thus a bit different than the argument made by the IMF in its external stability report, as the IMF was looking at fiscal expansion in surplus countries as a partial offset for monetary expansion. ** I suspect Japan’s fiscal stance has changed more than Europe’s fiscal stance. But I would like to confirm that the new stimulus will do more than offset the roll-off of past stimulus packages. If anyone reading this has a good estimate of Japan’s actual fiscal stance, please do let me know. Japan has carried out a meaningful fiscal consolidation over the past three years -- with more consolidation than implied by the rise in the consumption tax.

It turns out Germany has fiscal space even by German standards! Germany’s federal government posted a 1.2 percent of GDP fiscal surplus in the first half of 2016. The IMF was forecasting a federal surplus of 0.3 percent (and a general government deficit of 0.1 percent of GDP—see table 2, p. 41); the Germans over-performed.* Germany’s ongoing fiscal surplus contributes to Germany’s massive current account surplus, and the large and growing external surplus of the eurozone (the eurozone’s surplus reached €350 billion in the last four quarters of data, which now includes q2). The external surplus effectively exports Europe’s demand shortfall to the rest of the world, and puts downward pressure on global interest rates. Cue my usual links to papers warning about the risk of exporting secular stagnation. Martin Sandbu of the Financial Times puts it well. "The government’s surplus adds to the larger private sector surplus which means the nation as a whole consumes much less than it produces, sending the excess abroad in return for increasing financial claims on the rest of the world. German policymakers like to say that the country’s enormous trade surplus is a result of economic fundamentals, not policy—but as far as the budget goes, that claim is untenable. Even if much of the external surplus were beyond the ability of policy to influence, that would be a case to use the government budget to counteract it, not reinforce it." The Germans tend to see it differently. Rather than viewing budget surpluses as a beggar-thy-neighbor restraint on demand, they believe their fiscal prudence sets a good example for their neighbors. But its neighbors need German demand for their goods and services far more than they need Germany to set an example of fiscal prudence. It is clear—given the risk of a debt-deflation trap in Germany’s eurozone partners—that successful adjustment in the eurozone can only come if German prices and wages rise faster than prices and wages in the rest of the eurozone. The alternative mechanism of adjustment—falling wages and prices in the rest of the eurozone—won’t work. German fiscal expansion, especially if channeled to public investment that spurs private investment and spills over the rest of the eurozone, thus would help others achieve their fiscal goals. Stronger demand in Germany would raise exports, pulling up output and tax revenues. See this 2014 IMF working paper. If nothing else, Germany’s 2016 surplus allows the IMF to easily recalibrate its 2017 fiscal recommendation for the eurozone. It looks like the German fiscal expansion that the IMF initially projected for 2016 didn’t happen (the IMF projected a half point increase in government spending relative to GDP and a 20 basis points fall in revenue relative to GDP in 2016). Which makes it easy for the IMF to call for an expansion that brings the surplus down to zero in 2017, and in the process helps to offset the negative fiscal impulse likely to come from Spain and others. The IMF is still reluctant to call for external surplus countries to run (modest) budget deficits. But it has been willing to call for countries with external surpluses and budget surpluses to bring their budgets back to balance. * The general government balance captures spending by the regional governments, it provides a broader measure of Germany’s fiscal stance than the federal budget.

As a result of the Brexit vote to leave the European Union, the United Kingdom is likely to see another Scottish independence referendum in its future.

The eurozone collectively has a substantial external surplus, and its economy is operating below potential. In the framework set out in the IMF’s external balance assessment, that pretty clearly calls for fiscal expansion: "Surplus countries that have domestic slack need to rely more on fiscal policy easing, which would address both their output gaps and their external gaps... Meanwhile, deficit countries should actively use monetary policy, where available, to close both internal and external gaps." But is the IMF following its own advice (for a currency union that has an external surplus and domestic slack, I am well aware of the fact that the eurozone is not a single country with a single fiscal policy) and actually recommending a fiscal expansion in the eurozone? Best I can tell, no. Not for 2017. The IMF of course is for more fiscal stimulus at the European level. But that is a hope, not a reality. The capacity for a common eurozone fiscal policy conducted through borrowing by the center doesn’t currently exist, and it realistically isn’t going to materialize next year. That means the eurozone’s aggregate fiscal impulse is the sum of the fiscal impulses of each of its main economies. What does the IMF recommend there? In Italy the IMF seems to want about a half a point of structural fiscal consolidation (see paragraph 35 of the staff report). In France, the same (see paragraph 33 of the staff report). In Spain, the last IMF article IV called for a half a point of consolidation as well (see paragraph 33). That though is likely to be ratcheted up, as Spain hasn’t done much consolidation over the past two years and now will need to engage in a major consolidation to get to the Commission’s 3 percent of GDP fiscal target in 2018. Spain, Italy, and France collectively account for a bit more of the eurozone’s GDP than Germany and the Netherlands. So, is the IMF recommending enough fiscal expansion in Germany and the Netherlands to assure a positive fiscal impulse for the eurozone as a whole? No. The IMF is now advocating that Germany avoid returning to a structural surplus, and invest any windfall savings from higher than expected revenues or lower interest rates. But the IMF isn’t advocating Germany do any more on net than it already had done. Germany delivered a significant stimulus is 2016, but it was a one and done stimulus. Germany isn’t projected to generate a positive fiscal impulse in 2017.* The Netherlands needs stimulus on purely domestic grounds given persistent weakness in household demand and an ongoing output gap (see the "Tricky Balance" chart in the IMF’s external balance assessment). And the IMF did recommend a modest fiscal expansion in its last assessment of the Dutch economy. But also it didn’t protest too much when the Dutch government politely declined. See paragraphs 14 and 15 of the 2015 staff report. Bottom line: Germany’s 2017 fiscal impulse is projected to be neutral. The fiscal expansion the IMF recommended in the Netherlands for 2017 is not likely to be adopted and even if adopted it would be too small to offset the fiscal consolidation the IMF is recommending in Spain, Italy, and France. Given the weight of France, Italy and Spain in the eurozone, this implies the IMF is recommending that the eurozone as a whole consolidate next year. And in the IMF’s global framework, that implies the IMF is currently recommending policies that would tend to raise the eurozone’s external surplus. That goes to a larger global problem. The IMF’s framework for looking at external balances says, more or less, that intervention in the foreign exchange market has only a modest impact on external balances.** The policies that matter are healthcare spending, and of course, fiscal policy. The IMF always lives up to its mostly fiscal reputation. The implication, if the IMF wants to be symmetric and worry about global demand as well as global balance of payments adjustment, is that the IMF needs to be as aggressive in recommending fiscal expansion in surplus countries as it is in recommending fiscal consolidation in deficit countries. Judging by its recommendations in Europe, it still has a way to go. In addition to watching the IMF’s aggregate recommendation for the eurozone, I also will be watching the IMF’s 2017 fiscal recommendation for Korea—which has a German-sized current account surplus and, broadly speaking, a German fiscal policy (counting the off-budget surplus in Korea’s social security fund, Korea ran a general government surplus in 2015).*** And its last stimulus package seems to lack what the Japanese would call fresh water. There is of course a second, more straight forward argument for why the IMF might want to encourage Germany to do a bit more public investment in 2017: It offers the most obvious way to help insulate Germany from a slowdown in British demand. The IMF’s initial analysis of Brexit suggested it might knock 20 basis points off eurozone growth in 2017. The hit to Germany, though, was bigger—more like 40 basis points. Logical, given Germany’s greater dependence on exports. Germany’s 2017 nominal wage growth—judging from the contracts agreed this spring—also looks to be slower than in 2016. All in all, it would seem like there is ample reason for the IMF to encourage Germany to offset the impact of the drag expected from Brexit with a looser fiscal policy in 2017 and 2018, even if that means Germany would need to run small structural fiscal deficits for a time. It would support German growth in the face of an expected external shock. It would help ease the pressure on monetary policy when the ECB is at the zero bound. It would make it easier for Italy, Spain, and France to offset the demand drag from fiscal consolidation through exports, and thus facilitate the eurozone’s internal rebalancing. And it would help reduce the eurozone’s contribution to global current account imbalances. Note: edited slightly after publication; I had "internal" when I meant "external" in the last paragraph * Germany did provide a solid (around 1 percent of GDP) fiscal stimulus in 2016 in response to the migrant crisis, as the IMF estimates it moved from a 70 basis points of GDP general government surplus to a 30 basis point of GDP general government deficit. But now that Germany no longer has a surplus, the politics of further stimulus get complicated. The IMF’s staff report emphasized that any further public investment needs to be Within the fiscal rules ("Fiscal resources available within the envelope defined by the fiscal rules, including in case of overperformance, should be used to finance additional public investments...") and the debt brake doesn’t leave much space (see paragraph 49 of the 2016 staff report; the fiscal impulse is from table 2 of the staff report. ** This gets technical. In the IMF’s analytical framework, the intervention variable is interacted with the capital controls variable, reducing its impact. The capital controls variable is never “1.” For China, for example, it was 0.5 last year. So a percentage point of GDP in Chinese intervention could not have more than a roughly 17 basis point impact on the current account (the 0.45 intervention coefficient is multiplied by capital controls, which are now rated at 0.38 on a 0 to 1 scale. For Korea, a percentage point of GDP intervention could not have an impact of more than 6 basis points, given the 0.13 intensity of Korea’s controls. This is well below the impact that the Peterson Institute’s Joe Gagnon has estimated. And the impact is further reduced by the fact that the relevant variable is the gap between a country’s current level of controls and the optimal level of controls. So if the IMF (wisely) believes China isn’t ready yet to liberalize its financial account, the impact of intervention in generating a “policy gap” falls further. Right now, given the size of the capital controls gap for China, a dollar of intervention in China results in only a ten cent change in the current account. It doesn’t matter much now, as emerging markets sold reserves in 2015 and so far in 2016. But the net effect is that in the IMF’s framework, intervention never had much of an aggregate impact even back when there was a lot of intervention. *** The IMF is recommending medium-term fiscal consolidation in Japan, China, and the eurozone. Fairly substantial consolidations too (see table 3 of this report, look at what the IMF calls P* or "optimal" policies and compare that with the current estimated fiscal balance; the full underlying analytics are here). It is recommending a small medium-term fiscal expansion in Sweden and Korea. Both countries ran general government surpluses in 2015, and the IMF is calling them to bring those surpluses to zero or run a small (10 basis points of GDP) general government fiscal deficit. But the resulting swing in the fiscal balance is modest relative to the size of the Swedish and Korean current account surplus. For Germany, the IMF is recommending a fiscal expansion relative to its 2015 surplus; but, as noted above, that stimulus occurred in 2016, and the IMF isn’t currently calling for more stimulus. I should note here that the recommended fiscal stance in the IMF’s external balance assessment is for the medium term; just because the Fund recommends a medium term on-budget consolidation for say China doesn’t mean it recommends an immediate on-budget fiscal consolidation. That said, given China’s extremely high national savings rate and the need for corporate deleveraging, I personally do not see why China could not sustain on-budget fiscal deficits of around 2 percent of GDP in the medium term.

Rules are rules and all. But the application of poorly conceived rules is still a problem. Especially in the face of a negative external shock. The eurozone’s fiscal policy is, more or less, the fiscal policy adopted by its constituent member states. Wolfgang Schauble (do follow the link) should be happy: Europe’s fiscal policy is almost entirely inter-governmental. The eurozone’s big five—Germany, France, Italy, Spain, and the Netherlands—account for over 80 percent of the eurozone GDP. Summing up their national fiscal impulses is a decent approximation of the eurozone’s aggregate fiscal policy. And, building on the point I outlined two weeks ago (and that my colleague Rob Kahn echoed on his Macro and the Markets blog), 2017 could prove to be a real problem. Bank lending now looks poised to contract, and eurozone banks face (yet again) doubts about their capital. And the sum of national fiscal policies—best I can tell—is pointing to a fiscal consolidation. In the face of the Brexit shock, standard (MIT?) macroeconomics says that a region that runs a current account surplus, that has a high unemployment rate, that has no inflation to speak of, that cannot easily respond to a short-fall in growth by lowering policy interest rates (policy rates are, umm, already negative, and negative rates are already, cough, adding to problems in some banks), and that can borrow for ten years at a nominal interest rate of less than one should run a modestly expansionary fiscal policy. The eurozone as a whole clearly has fiscal space. The eurozone’s aggregate fiscal deficit is lower than that of the United States, Japan, the United Kingdom, and China. Adjusted for the cycle, the IMF puts the eurozone’s overall fiscal deficit at about 1 percent of GDP (without adjusting for the cycle, the eurozone’s overall deficit is around 2 percent of GDP). Even without any cyclical adjustments, the eurozone now runs a modest primary surplus, and simply refinancing maturing debt at current interest rates should lead to a lower headline deficit. But the eurozone isn’t a unified fiscal actor. Right now the countries that could run a bigger fiscal deficit without violating the eurozone’s rules have said they won’t, and the countries that are already running deficits that violate the rules are facing new pressure to comply with the rules. The aggregate fiscal stance of the eurozone thus is likely to be contractionary. Germany of course is the best case of a country that the market wants to finance. Germany actually did do a fiscal expansion in 2016. It had a fiscal surplus of almost a percent of GDP in 2015, and in 2016 it is projected to be in balance. (See the IMF Article IV report) But on current plans Germany won’t do more in 2017 as more would mean a deficit. The fiscal impulse from here out is thus likely to be flat, barring a major policy shift. The Dutch have, by any reasonable estimate, enormous fiscal space (massive current account surplus, low gross debt, tons of pension assets, and, the market is willing pay the Dutch government to borrow, at least for maturities shorter than ten years). But the Dutch too do not seem to want to use their fiscal space. The European Commission lauded the Netherlands fiscal policy precisely because it was committed to bring a 2 percent of GDP fiscal deficit down to between 1 and 1.5 percent of GDP in 2017. With a structural deficit estimated to be a bit over 1.5 percent of GDP in 2015, the commission believes further consolidation is required to get the Dutch structural deficit down to the target of half a point of GDP. No matter that there has been a persistent problem with demand in the Netherlands. France has somewhat higher debt levels than Germany or the Netherlands. But a country that currently can borrow for ten years at twenty basis points, a rate well below the interest rate the market charges the United States, also doesn’t need to consolidate today. Consolidation now—if you believe Fatás and Summers—might well raise debt to GDP levels. But that doesn’t seem to be the commission’s view. The commission’s 2015 report emphasized that France had failed to do enough structural consolidation in 2015, and argued it wasn’t planning to do enough in 2016 either. It is hard to see the commission changing its tune for 2017.** Italy is gearing up for a bit of bank recapitalization. Without a bit of flexibility, the accounting for the recapitalization will push Italy’s headline deficit above 3 percent. The odds are Italy will be called to tighten, at least a bit. Especially because Italy is going to be more or less permanently in violation of the rule that says that European countries with high debts need to bring down their debt-to-GDP ratios with austere budgets. And then there is Spain. Together with Portugal, it runs the risk of being sanctioned by the commission for an excessive deficit. Five percent of GDP isn’t all that close to three percent of GDP. The Financial Times reported back in March: "Spain has veered sharply off course in its long-running effort to reduce the budget deficit, unveiling a 5.2 per cent shortfall in 2015 that is likely to raise alarm inside the European Commission and impose significant political constraints on the next Spanish government... The shortfall is almost a full percentage point above the deficit target set by Brussels ... Crucially, the gap also makes it all but impossible for Madrid to comply with its target of reducing the shortfall to below 3 per cent of gross domestic product this year." Spain is now set to be sanctioned by the commission, which made clear in its 2015 report that Spain has been running far too loose a fiscal policy (never mind that demand is still down 10 percent relative to pre-crisis levels, that unemployment is shockingly high, and that the period of too-loose-for the-commission fiscal policy was a period of recovery) over the last two years. The commission recently indicated that Spain would have needed to do about 2 percent of GDP more consolidation to have hit European targets over the last several years. "The cumulative structural fiscal effort over the 2013-2015 period is estimated at 0.6% of GDP, significantly below the 2.7% of GDP recommended by the Council." It isn’t much of a leap to think that Spain will be asked to do to a bit of structural consolidation in 2017, and the fiscal impulse in Spain will turn significantly negative.*** So if Germany and the Netherlands won’t run a bigger deficit, and if France, Italy, and Spain are all supposed to consolidate, how exactly can the eurozone, as currently constituted, generate a positive fiscal impulse? It certainly won’t come from Portugal. While there is room to debate the correct fiscal stance for each individual country, it also seems clear to me that the sum of the commission’s national fiscal recommendations would imply a reasonably contractionary fiscal policy for the eurozone as a whole. And if applying the national rules produces a policy that it is too tight for the eurozone as a whole, that to me implies that the rules as currently constructed are part of the problem. Tis a shame really. In 2016 the eurozone was actually experiencing somewhat decent growth pre-Brexit. Eurozone growth exceeded U.S. growth in q4 2015 and q1 2015. And if you have a Keynesian bent, you can explain the eurozone’s 2016 growth pretty easily. Events conspired to make the eurozone’s fiscal stance for 2016 fairly expansionary. The Germans stopped running a 1 percent of GDP fiscal surplus. The Dutch, it seems, quietly allowed their structural deficit to widen a bit. And Spain got a reprieve going into its election cycle. The IMF recently estimated the eurozone structural deficit widened by about 40 basis points of GDP in 2016, generating a positive fiscal impulse in Europe for the first time in a long time. Many smart observers of European policy tend to think the eurozone’s 2017 fiscal stance won’t be as bad as I fear. They argue that the commission’s position is just an opening bid designed to raise their credibility in Germany, and pragmatism will win out in the end. I am not so sure. On Europe’s current course, there is a real risk that renewed bank deleveraging will be combined with renewed fiscal consolidation. * One percent comes from looking at the GDP weighted average 10 year rate. ** The IMF, unfortunately, echoed the commission in its Article IV report on France: "Structural adjustment over 2015–18 is projected to average 0.1 percent of GDP, well below the EC’s recommendation. Without further efforts, France will not reach the structural balance objective within the five-year projection horizon." See p. 11. *** More on Spain from the commission; the cumulative shortfall in fiscal effort now looks to be about 3 percent of GDP: “On a cumulative basis over 2013-2016, the shortfall with respect to the effort that was recommended by the Council amounts to 3.1 pps, when measured against the uncorrected change in the structural balance, and to 4.4 pps. when referring to the corrected indicator."