How François Hollande can save the Eurozone

You’d be forgiven for not following the French presidential election very closely. The contenders have savagely attacked one another’s policies, parties and even mental faculties (Luc Mélenchon of the Left Front party called far-right Marine Le Pen a “half-demented bat”). Yet beneath the bravado, they have campaigned on strikingly similar platforms. The uniformly anti-globalisation, antifinance, anti-EU rhetoric that has characterized the campaign is depressing, and now that Mr Mélenchon has gone from the race, so has the comedy.

However, there is reason to be optimistic about François Hollande’s likely victory. He differs from Sarkozy in one important respect: he has promised that he will not ratify the European fiscal pact being pushed by Germany. Hollande has said that it will either have to be renegotiated from scratch or accompanied by an additional treaty with tools to promote economic growth. Like a Keynesian messiah come to save Europe, he told his supporters in Paris “austerity cannot be our horizon”.

Economists will be breathing a sigh of relief. The low spending and higher taxes demanded by the EU fiscal pact means less income for households and firms, which depresses economic activity. This isn’t just first year economics jargon, it’s a statistical fact. Crunch the numbers and it becomes clear that countries that impose austerity see a fall in their income.

 Why then, have Cameron, Merkel and Co. been telling voters that austerity, like exercise and getting your five a day, is for their own good? The economic recovery via austerity myth is based on two misconceptions. First, that profligacy by careless EU policymakers is the cause of the current recession. This is simply not true. Spain had low debt and a budget surplus before 2008. Ireland was in a similar position, while Italy stood out for its favourable deficit status. However, the financial crisis damaged their banking systems and caused a fall in growth, which forced the countries into deficits. Debt is the symptom, not the cause.

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 The second mistaken belief is that high debt spooks the bond markets, leading to high interest rates that hurt the financial system and inhibit growth. Yet Japan has maintained a whopping debt-to-GDP ratio of 230% without a bond crisis. America’s budget is in a far worse mess than the Eurozone’s, but American bond yields remain low. Investors are more likely to judge a country’s ability to repay its debt on its future growth prospects than on its deficit. Perversely, higher spending may be the best way to reduce debts in the long run.

 As Spain and Britain fall back into recession and bond yields continue to jitter, it is hard to know what it will take for policy makers to acknowledge that their austerity policies have failed. Hollande deserves credit for putting growth back on the table. Merkel et al. should listen up.