Expect a Financial Crisis in Europe With France at the Epicenter

by Mish Shedlock, Mish Talk:

The EU never enforced its Growth and Stability Pact or Maastricht Treaty rules. The crisis is coming to a head with France and Italy in the spotlight. The first casualty will be Green policy.

Compliance Rules

1. Deficit rule: a country is compliant if (i) the budget balance of general government is equal or larger than -3% of GDP or, (ii) in case the -3% of GDP threshold is breached, the deviation remains small (max 0.5% of GDP) and limited to one year.

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1. Debt rule: a country is compliant if the general government debt-to-GDP ratio is below 60% of GDP or if the excess above 60% of GDP has been declining by 1/20 on average over the past three years.
2. Structural balance rule: a country is compliant if (i) the structural budget balance of general government is at or above the medium-term objective (MTO) or, (ii) in case the MTO has not been reached yet, the annual improvement of the structural balance is equal or higher than 0.5% of GDP, or the remaining distance to the MTO is smaller than 0.5% of GDP.
3. Expenditure rule: a country is complaint if the annual rate of growth of primary government expenditure, net of discretionary revenue measures and one-offs, is at or below the 10-year average of the nominal rate of potential output growth minus the convergence margin necessary to ensure an adjustment of the structural budget deficit in line with the structural balance rule.

Deficit Disaster Zones

France and Italy are major disasters right now on the budget deficit rule. France has a budget deficit of 7 percent and Italy 5 percent.

France needs to reduce its deficit by a whopping 4 percent of GDP!

Neither Italy nor Greece should have been allowed in the EMU (European Monetary Union – Eurozone) in the first place.

Greece has a debt-to-GDP ratio of 170 percent. The target is 60 percent.

But the lead chart tells the picture. Only the Scandinavian countries are in compliance.

Looser Rules Postpone the Crisis

On February 10, the EU agreed to Looser Fiscal Rules to Cut Debt, Boost Investments.

The latest revamp of two-decades-old rules known as the Stability and Growth Pact came after some EU countries racked up record high debt as they increased spending to help their economies recover from the pandemic, and as the bloc announced ambitious green, industrial and defense goals.

The revised rules allow countries with excessive borrowing to reduce their debt on average by 1% per year if it is above 90% of gross domestic product (GDP), and by 0.5% per year on average if the debt pile is between 60% and 90% of GDP.

Countries with a deficit above 3% of GDP are required to halve this to 1.5% during periods of growth, creating a safety buffer for tough times ahead.

Defense spending will be taken into account when the Commission assesses a country’s high deficit, a consideration triggered by Russia’s invasion of Ukraine.
The new rules give countries seven years, up from four previously, to cut debt and deficit starting from 2025.

Note that the EU can tweak enforcement but not the baseline Stability and Growth Pact targets themselves without unanimous agreement, and a new treaty.

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