THE STATE OF THE EUROPEAN UNION REPORT. Europe in a period of transition

THE STATE OF THE EUROPEAN UNION 66 about price rises, while the fear of slower growth has resurfaced. These swings underline the need to proceed with caution in response to calls to withdraw fiscal and monetary stimuli or to raise interest rates. The current priority must be to consolidate the recovery of economic activity and employment, and this means leaving possible interest rate changes for the future, once the data permits a solid structural analysis which isolates the temporary impact of reopening. In addition, to comply with the Federal Reserve and ECB goals of an average inflation rate of 2 per cent, it is necessary to allow a certain margin for price increases, particularly following a decade during which inflation has been below this target. The ECB itself has stated the need for a degree of flexibility in price controls during the recovery period, as Christine Lagarde explained on 8 July 2021 when announcing the new medium-term inflation target of 2 per cent, following a strategy review. Conclusions Analysis shows that both the direct spending measu- res taken by the United States (around 25 per cent of GDP) and the combined measures taken by the European Union (approximately 15 per cent of GDP) have been unprecedented in their scale. However, it is clear that the fiscal effort of the United States has been considerably greater and, in part, this is due to the different break- down of the spending, which is federal in the case of the USA while in the EU it has been Member states who have been responsible for the majority of the fiscal effort (around 11 per cent of GDP). This suggests that the di- fferentiating factor lies not in economic policy but in the historical-institutional dimension (Ruiz Devesa, 2021), with the lower degree of federal development in Europe constraining the EU’s capacity for action. The European Union was created 70 years ago, at which point the United States had already been in existence for more than a century and a half. Since its establishment in 1787, the United States has seen the continuous strengthening of the federal level through a number of mechanisms, including the consolidation of state debts in 1790, the establishment of federal in- come tax and a central bank in 1913, followed by major federal spending programmes: Roosevelt’s New Deal in the 1930s and 1940s, and Johnson’s “Big Society” in the 1960s. The power of central government was further strengthened followingWorldWar Two and the ColdWar. By contrast, the process of EU integration has been hin- dered by the dominance of German ordoliberalism, which has left its mark on Europe’s “economic constitution”. As a result, the creation of the euro had to be offset by the Stability and Growth Pact, which sets strict limits on deficits and public borrowing, and prohibits the ECB from funding Member states or the EU as a whole, conditions that have no parallel in the US constitution. These limits have an an impact on the political op- tions that have been prioritised in the fight against cov- id-19 in Europe. For example, in the United States, there are no major barriers to implementing direct transfer programmes to citizens, as the Federal Reserve issues the world’s benchmark currency, and the US therefore does not face the issue of risk premiums, unlike some Eurozone countries. This problem could be circumvented in Europe if the ECB introduced a programme of direct funding of households to stimulate aggregate demand at this critical time, something it is legally able to do. How- ever, the mistaken belief that this would be equivalent to monetary funding of public deficits, and a monetary policy that has historically been hostage to the spectre of hyperinflation have limited the introduction of such measures in Europe. The fear of hyperinflation also carries the risk of a premature withdrawal of stimuli or a restrictive monetary policy which could compromise the incipient recovery.The withdrawal of support is something that must be avoided, particularly when new variants of covid-19 introduce a further element of uncertainty about the short-term eco- nomic future. Instead, it is important to keep all monetary and economic policy options open, including a second European Recovery Plan if this were to prove necessary.