G. Bartoli: FISCAL SPACE IS BACK
It's not a joke invented by Krugman: the EC is pushing for expansionary fiscal policy, but it will recommend the contrary to euro area countries. The resulting effect will be contractionary. This schizophrenic behavior is argued in the EC’s recently issued Communication 7271. The reasoning is that the Commission’s Autumn economic forecasts point to anemic growth, as well as lasting underemployment of labor and capital. Combined with stagnant exports, these factors will drive Europe into a low-growth-low-inflation trap à la Japanese.
The Commission candidly states that “the fiscal requirements contained in the country-specific recommendations of the Council would lead […] to a moderately restrictive fiscal stance for the euro area as a whole in 2017 and 2018, while the economic situation would seem to call for an expansionary fiscal stance”. The reason for such a call is a far from pre-crisis level of GDP in the EA eight years after the financial crisis, higher debt-to-GDP ratios in most countries, not despite, but because of a restrictive fiscal stance, while potential GDP has also fallen because of scarce investment and high unemployment, which have reduced both physical capital and skills.