Euro zone governments know by now that they will miss their official fiscal deficit targets next year in spite of significant consolidation efforts. After the IMF and the European Union forecasts a few weeks ago, the OECD has just confirmed the foolishness of target fetishism. If austerity creates the problem, how can more austerity ever solve it?
The OECD numbers yet again show that Spain, Italy, France and Portugal won't be able to reduce their fiscal deficits as much as their governments have pledged. Now it is important that policy makers – especially those in Berlin – properly understand the reason for the shortcomings. The goals will not be missed because of governments ignoring their promises and spending irresponsibly, as deficit hawks in northern Europe feign to think.
In fact, the opposite is true. Southern European governments are pursuing ambitious austerity goals. In Spain, for example, tax hikes and spending cuts will add up to a total consolidation of 3.3 per cent of GDP in the next two years.
The key reason for the looming disappointments is that growth prospects are significantly grimmer than previously assumed. The currency area is enduring yet another recession which hurts tax revenue and drives up social security and welfare spending.
Governments must accept this, as the OECD points out. Attempts to fight growing deficits with even more austerity can only exacerbate the fiscal woes. Europe has long reached the point where austerity has become self-defeating.
Excessive fiscal consolidation is already one of the key reasons for a lack of growth, as mounting empirical evidence collected by the IMF and the OECD shows. Even worse, in the current economic environment, spending cuts and tax hikes turn out to be more harmful to growth than in normal times. This is due to three reasons: traditional monetary policy has run its course; a number of governments are consolidating simultaneously; and battered banks are limiting credit supply to the private sector.
In other words, the only way for Europe ever to meet its fiscal targets is to ignore them for now.