Tuesday, June 3, 2014

France And Italy Are Caught In An Economic And Poitical Trap

Economic and political problems continue to escalate in the eurozone.  France and Italy are the second and third largest economies in the eurozone and they are not meeting the economic goals set by the European Commission.  Budget deficits in both countries continue to grow as a percent of GDP.  The basic problem is slow economic growth in both countries.  Slow growth means slow growth in tax revenues.  Its difficult to cut budget deficits when tax revenues are not growing.  When that happens, the government can either cut spending, which might slow down economic growth even further, or it can cut taxes which might stimulate the economy, but it may also cause budget deficits to rise even further.

The fiscal austerity demanded by the European Commission may worsen the economic problems in France and Italy.  Furthermore, it will not be easy to implement unpopular spending cuts demanded by Brussels after the strong performance of euroskeptic parties in the European elections.

Leaders in the European Commission continue to be committed to neoliberal economic ideology.  The central tenet of this ideology is that France and Italy can become more competitive by making difficult structural changes in their economies.  That usually translates into making their labor markets more flexible.  It is assumed that wages will fall and make their products more price competitive in export markets.  Falling wages, however, are a double edged sword.  Lower wages may make their products more competitive in export markets, but they will also reduce consumer demand in their domestic markets.

The eurozone is also struggling with another problem.  Prices continue to fall throughout the eurozone.  The inflation rate is well below the 2% target and there is a risk of deflation in the eurozone.  Deflationary spirals are very difficult to stop.  The central bank may use more aggressive monetary policies to stimulate demand but it is unlikely that they will be as aggressive as those that have been employed in the US.  Inflation in the US is still well below its 2% target.

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