Debt troubles, fiscal policy and the Euro

Recently, Greek debt problems have risen concerns about the stability of the Euro Zone. Several magazines have dealt with this issue, wondering about the possibility of bailing-out the European economies with serious public finance problems, like Greece, Spain, Ireland and Italy. As written in “The Economist” last week (here), would more stable euro members (e.g. Germany and France) rescue them? Would default by one of the problematic country threaten the existence of the Euro? Would a defaulter leave the Euro Zone? These issues are also well tackled by other magazines (see, for example, the “Business Week”).

However, I would like to focus here on the fiscal policy trade-off associated with this problem. Indeed, as stressed in the above mentioned article of “The Economist”, Greece, Spain, Ireland and Italy are using the fiscal tool in very different ways. Moreover, the current recession is not helping these countries. The trade-off faced by them is serious: they have to decide between fiscal tightness to maintain the budget deficit at an acceptable level, and fiscal expansionary policies to stimulate the economy during the severe recession. Italy's Finance Minister is following the first approach, while other countries are running higher deficits.

Source: The Economist (N. 8660)

Unfortunately, there is no consensus among experts and politicians on which type of fiscal policy should be used in these cases, especially during a recession. Furthermore, the debate cannot ignore other elements, such as possible bail-out guarantees and investors- and consumers behaviour. The issue is particularly ticklish and involves a rethinking of the fiscal-monetary framework in the Euro Zone, whose future depends intrinsically on how the problem will be addressed.