I never expected a message of austerity to emerge from the Palace of Versailles, where Nicolas Sarkozy, France’s president, spoke last week to outline his economic strategy for the rest of his term. He left no doubt that he is not prepared to follow Angela Merkel, Germany’s chancellor, in the direction of a balanced budget. Instead, he distinguished between “good” and “bad” government deficits, went on to explain that a good deficit is cyclical, a bad deficit structural, and then produced yet another category: a temporary deficit that would be brought down through higher economic growth in the future.
In theory, this is all fine. In practice we have reason to doubt whether he will make an earnest effort to get rid of the deficits, good or bad. One can have endless debates about the relative benefits of Germany’s legalistic approach or Mr Sarkozy’s alternative version. Whatever side of the debate you support, you will probably agree that it is not a good idea for the two largest members of the eurozone to move in opposite directions.
In fact, it could prove highly destabilising to the eurozone. Germany, as I argued last week, is heading in the direction of a zero level of government debt in the long run as a consequence of a new constitutional balanced-budget law. It is perhaps not intuitive that a balanced budget, pursued indefinitely, would eventually lead to a complete eradication of public debt. But this is what will happen.
In fact, Germany’s new law imposes an upper deficit ceiling of 0.35 per cent of gross domestic product over the economic cycle. But remember this is a ceiling. There is no floor. If the cyclically adjusted deficit came in exactly at that ceiling, year after year, and assuming a nominal rate of output growth of 4 per cent, this would stabilise Germany’s debt-to-GDP ratio at just under 10 per cent. So if this constitutional law sticks, Germany’s debt-to-GDP ratio will settle somewhere between zero and 10 per cent in the long run.
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