ECB’s Papademos warns eurozone members to stick to tight fiscal policies or risk higher rates

FRANKFURT (Reuters) – European governments need to renew their commitment to sound public finances or they risk higher interest rates and less economic stability, European Central Bank Vice President Lucas Papademos said yesterday. How strictly politicians enforce Europe’s new budgetary rules is likely to face a stern test in coming months with Italy running a 4 percent budget deficit and revised data showing it broke limits for three of the past four years. At an ECB Watchers’ conference, European Union policymakers and economists joined Papademos in urging politicians to respect the new Stability and Growth Pact. Failure to do so, Papademos warned, could affect ECB decision-making on interest rates. «Unsound fiscal policy that results in excessive and persistent budgetary deficits is one source of risk to price stability that has to be assessed in the formation of monetary policy,» Papademos told the conference. Slow economic recovery has made governments reluctant to risk stifling short-term demand by raising taxes or cutting spending to bring their budget shortfalls into line. Under the stability pact, EU countries must limit their budget deficits to 3 percent of gross domestic product, but government ministers on the European Council refused to enforce penalty clauses against France and Germany in 2003. In March 2005, ministers agreed to a revised pact, which increases the number of reasons governments can give for temporarily breaching the deficit limit, but also places more onus on governments to act prudently in economic upswings. Papademos said the test for this new budgetary framework, considered essential to making monetary union work, is how strictly national governments apply the rules. «A rigorous and consistent implementation, in line with renewed political commitment to the fiscal framework, is crucial for sound public finances in the euro area,» he said. While the Stability and Growth Pact strictly applies to all 25 EU countries, the ECB is particularly concerned that an out-of-control deficit in one or more eurozone countries could push up market interest rates, affecting all 12 countries in the currency bloc. Michael Deppler, director of the International Monetary Fund’s Europe department, said that the new pact means that individual countries must stop making the European Union a scapegoat for their budget woes. «Brussels will no longer be an excuse for doing things. You will have to do things because it’s good for that country per se,» he told the conference. Critics of the revised budget pact worry that the numerous exemptions allowed for countries in economic difficulties will make the pact unenforceable and that it relies too heavily on the good will of national governments to implement it. German Deputy Finance Minister Caio Koch-Weser conceded his country has problems on this front, and said Germany should adopt a national pact to cut its deficit. «The locus has moved back to (national) capitals. We need more of an ownership of stability guidelines,» he said. This becomes even more pressing given that Europe’s population is forecast to age rapidly in coming decades, leaving fewer workers to service the previous generation’s debts. «It is essential that popular support be won for budget cuts,» IMF’s Deppler said. «People just need to be aware of the underlying unsustainability of the fiscal situation they face. The European Commission has talked at length about this, but they (European citizens) just don’t seem to believe it,» he added.

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