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François Hollande And The EU's Alternatives

Major political change is afoot in France, where a presidential election has brought anti-austerity politician François Hollande to power. In the face of the EU’s economic crisis, incumbent president Nicolas Sarkozy has cooperated closely with German chancellor Angela Merkel to push for tough austerity measures. Now, France’s leadership is poised to go in a different direction. Merkel is already declaring that there will be no renegotiation of the EU fiscal pact, but Hollande is demanding that the agreement “be expanded to include measures to stimulate economic growth.” What kind of alternate path could the EU take?

A paper issued in February offers some ideas. The authors, both economists in Portugal, argue that “solutions to the euro-area crisis proposed by the EU governing institutions in cooperation with the IMF, based on further austerity and wage cuts, will worsen the crisis” and “are likely to further reduce the real GDP growth of these countries.” That’s because austerity lowers the growth of internal aggregate demand, which dampens GDP growth and increases countries’ sovereign debt-GDP ratio. Yes, the authors acknowledge, announcements of austerity cuts can have positive short-run effects, but that’s largely because expectations are so low to begin with: When markets are prepared for the worst (like a country defaulting on its debt), austerity cuts sound almost like good news, even if they’re likely to fail eventually. So what could the EU do differently? The authors suggest a range of measures aimed at reducing interest rates, increasing demand, and reducing current-account deficits. These include using the European Central Bank as a direct lender of last resort, increasing stimulus spending in Germany, focusing on country-specific fiscal policies (rather than one-size-fits-all approaches to national budgets), and implementing country-level monetary policies designed to keep real interest rates low. It seems unlikely that this wish list will be fulfilled anytime soon, but its prospects are a little brighter this week.