Over the past two years, European governments have turned on the fiscal taps, pouring some 530 billion euros into the eurozone to fight the fallout from the pandemic and Russia’s invasion of Ukraine. Now they are closing them. This surge in austerity seems short-sighted. The state budget and debts are manageable. Eurozone finance ministers should use the extra funds to boost growth, help low-income groups and push through structural reforms. If they don’t overdo it, governments can also soften the blow of the European Central Bank’s efforts to curb inflation. Many European citizens are still worried about how they will pay their utility bills. But eurozone leaders such as Germany’s Olaf Scholz, France’s Emmanuel Macron and Italy’s Georgia Meloni are facing pressure from economic policymakers to cut benefits. ECB Governing Council member Philip Lane warned at the end of 2022 that a widening budget deficit would lead to higher interest rates. Most central bankers and governors recognize that slowing growth and rising costs of living require government intervention.

However, as ECB President Christine Lagarde is fond of saying, public funds must be subject to a clear rule with three conditions: they must be temporary, target a certain type of economic shock, and target the most vulnerable groups in society. Without these limits, government spending will push up consumer prices or even lead to the collapse of sovereign bonds, as happened in the UK last September. European leaders appear to be honoring this commitment. After a 3.75% increase in GDP between 2020 and 2022, the eurozone’s overall “fiscal position” – a measure of the cost of measures taken by governments – will return to neutral this year, according to the European Commission. However, such austerity looks out of place when the government’s budget deficit is taken into account. The gap between government revenue and spending is shrinking. The Commission estimates that the total eurozone deficit will be 3.7% of GDP in 2023. This is close to the pre-pandemic level of 3.5% and well below the 7% reached in 2020. Meanwhile, public debt is becoming more manageable.

The total borrowing of eurozone member states as a percentage of GDP will fall to 92% in 2023 from 99% three years earlier, helped by inflation pushing up the nominal value of economic production. It is true that six countries—Belgium, Greece, Spain, Italy, France, and Portugal—will still be in debt for more than one year of economic production. But of these, only Belgium will see an increase in its leverage. For public finances to remain sustainable, the cost of government borrowing must be lower than the increase in resources available to service that debt, as measured by nominal GDP growth. Germany, Spain, France and Italy have been in the best position since at least 2001, according to a recent ECB staff blog post. Even in Italy in 2021 and 2022, funding conditions were among the best in two decades.

Admittedly, this favorable environment will worsen in 2023 as inflation eases and ECB rate hikes push bond yields higher. Ultimately, however, funding conditions will remain favorable.