Caught up in a war with Russia, and in increasing trade frictions with China, the current European leaders have ignored deteriorating economies at their own peril.

Policies to restore the E.U.’s peace and security are nowhere in sight, and the broadening trade conflicts with China could easily get out of control.

Epochal socio-political changes are unfolding.

People have spoken during the recent E.U. parliamentary elections. The governing parties in countries like France and Germany have taken a beating by a massive move of votes to opposition parties on the right.

Undeterred and blindly supported by the mainstream media, the losers keep losing by insulting voters for favoring rightwing parties and stirring up what were largely moribund leftist formations. The struggling elites in power, with their media in tow, are semantically erring by derisively calling their opponents “populists” – political activists who get their votes for showing that they care about common people’s rights and interests.

A fiscal balance must be restored

In the middle of that ongoing maelstrom, the E.U. Commission announced on June 19, 2024, a sanctions procedure against seven member countries whose budget deficits and public debt exceed the Maastricht Treaty rules with respect to budget and public debt positions.

And then, in a clumsy bureaucratic maneuver, the Commission made a statement that this was just a warning to repeat fiscal rule offenders.

One wonders whether anyone cares about the credibility and professional competence of E.U.’s top executives. Announcing procyclical sanction procedures for failing to raise taxes and cut government spending during times of lingering recessionary pressures is a redux of a German diktat more than a decade ago to “teach a lesson to spendthrifts …”

That led to a deep recession in 2012 and miles long Caritas soup kitchens in a rich post-modern European democracy -- but German taskmasters did not care.

This time, it may also be that the E.U. Commission wanted to send a signal to France, where the losing elites currently in power can use the warning to scare people away from voting for Euroskeptic and increasingly popular rightwing opposition parties.

At any rate, France and Italy do need to address their calamitous public finances as soon as some recovery begins to take hold.

The French budget deficit last year came in at 5.5% of GDP, and the public debt at 117% of GDP is expected to climb to 120% of GDP by the end of this year. That is nearly double the Maastricht rule of 3% of GDP for budget deficits and 60% of GDP for public debt.

Italy’s fiscal situation is much worse, with a budget deficit last year at 7.4% of GDP and a public debt at 151.2% of GDP.

Monetary policy cannot do much

That is a very unfortunate situation, but forcing a round of fiscal austerity on France and Italy under present cyclical conditions would just precipitate both countries into deep recessions, while increasing their budget deficits and public debt. And with Germany already in a structural downturn, two-thirds of the monetary union (aka the euro area) would be thrown into an intractable period of declining demand, output and employment.

An obvious question is: Can the monetary policy help?

The answer is: Not much, if at all. And there is also the problem that Mario Draghi, a superb economist, is no longer leading the European Central Bank (ECB).

With the euro area inflation rate of 2.6% (in May), the ECB’s real policy rate of 1.15% (i.e., policy rate of 3.75% minus inflation rate of 2.6%) is inappropriate for cyclical conditions where the economic growth has stagnated over the twelve months to the first quarter of this year.

Continuing to fight the service sector inflation of 4.1% with such monetary policies will only lead to weak demand and output, because the service sector is sheltered from competition. Structural reforms are, therefore, needed to achieve a better balance between demand and supply in that particular market segment.

The E.U. labor markets also need similar attention. A 5.8% annual increase in hourly wage and salary costs during this year’s first quarter are seriously at odds with an economy whose domestic demand was dead in the water.

The ECB may wish to urge two major structural changes.

One, of the seven countries exceeding the Maastricht fiscal rules only Hungary and Poland are not members of the monetary union. The remaining five euro area countries should be put under a strict fiscal supervision, with clear deadlines for completing the adjustment.

Two, countries with dysfunctional labor and service markets should be asked to implement reforms that would eliminate excessive price rigidities.

The scope for an ECB meaningful monetary easing is very limited. Interest rate cuts cannot deal with structural problems, consumer and business uncertainties raised by epochal socio-political changes, and the vicissitudes of Europe’s crumbling security architecture.