The blind faith in the demands of convergence

As the German government chooses to back the raise in TVA in order to bring ameliorate the public budget we are compelled to to ask why or at least to question the economic justifications?

Firstly, let us re-coup those demands of convergence for a moment ...

- Low inflation rates – The RPI (retail price index) of a country must not rise above 1.5 % of the RPI in the three countries with the lowest inflation rate.

- A country must maximum have a budget deficit amounting to 3 % of GPD.

- The public debt must not exceed 60 % of GPD.

- You must have a stable currency. Other currencies following the Euro into phase three must not deviate from the value of the Euro by more than 2.25 % and there should have been no devaluation of your currency two years prior to your entrance into the fixed currency regime of the Euro zone.

The important point in relation with the TVA raise in Germany come from the FT.

"The government has admitted that economic growth – projected by some economists to double this year to 1.8 per cent from 0.9 per cent in 2005 – is likely to fall again in 2007 to around 1 per cent, partly due to the VAT rise.

Peer Steinbrück, finance minister, speaking in parliament, said the VAT rise was “painful but necessary” in order to consolidate Germany’s strained public finances and meet the criteria of the European Union’s stability pact. Germany hopes in 2007 to reduce its budget deficit to below 3 per cent of GDP for the first time in five years."

So, a painful but necessary policy adjustment? It certainly seems painful but was it also necessary? It is policy making such as this that make the economics of the Eurozone seem rather odd or at least without sound justification.And as Germany embarks on what looks like a suicide mission in order to abide to the demands of convergence set by Eurozone. 

For a perspective on this I can also point to a recent paper from Bruegel - Euro, only for the agile.

"Some countries have fared better than others under EMU. Table 1 documents the differences in real GDP growth rates across the euro area since 1999. Growth in Ireland, Greece and Spain has significantly outpaced average euro area growth, while Germany, Italy and Portugal have underperformed. Strong growth in Spain and Greece has been driven by
robust domestic demand, whereas their export performance has been mediocre."