The world economy is still stuck in a slow-growth environment. Japan is in the doldrums, Europe is griding to a halt and only a few countries are showing any signs of growth. Australia, Canada and to a lesser extent Great Britain have been relatively well in the global economic growth league tables, but the world economy remains dangerously and depressingly dependent on the performance of the US economy. Growth in the US has been far stronger than in Europe, but there is a lingering sense of fragility to the current recovery. Unemployment may not be very high, but it hasn't started to come down yet. Consumer confidence is low, retail sales weren't as strong as expected, capacity utilization is very low, and capex is lagging the cycle. Despite all that, the economy is still growing at a pretty decent pace (and much more strongly that most European economies), but any of the aforementioned factors could become a more serious problem.

Faced with the slowdown in economic growth, the difference in policy response between the US and the Eurozone is striking. Whereas in the US both monetary and fiscal policy are aligned to boost growth, policy in Europe on both fronts is either paralyzed or even actively counterproductive. The Federal Reserve is fully on board in getting the economy moving again; Alan Greenspan is much more scared of deflation than of inflation. We know the cure for the latter; curing the former is much harder. President Bush's proposals for a $670 billion stimulus program over the next 10 years is bold and ambitious. The Democrats' program also aims to restore growth, although their proposals are far less likely to be effective. Be that as it may, there is broad consensus on the need for stimulating growth in the US even if there is disagreement on the means by which to achieve it. Double taxation of dividends is something that should never have happened in the first place, although the current proposals have problems of their own. Ironically it was President Carter who last tried to get rid of the double taxation of dividends in 1979, but it was corporations who lobbied against it, and I suspect many CEOs would prefer to keep the double taxation. Why? Because it encourages companies to retain earnings rather than pay them out as dividends, which means that CEOs have more money to play with. But the Bush plan also calls for $300 billion in other tax cuts as well, which will definitely help the economy. Given the timing of passing legislation and the structure of the tax cuts, the bigger boost is likely to come in 2004 rather than 2003, although the 2003 effect is also positive.

This will, of course, increase the budget deficit. The fiscal boost to the economy over the last two years has already been substantial mostly due to the Bush tax cuts and the increase in defense spending following September 11th. So how big a budget deficit is acceptable? Both total US government debt and the budget deficit will increase initially with the tax cuts. But, given the economic circumstances, if you're going to increase the budget deficit, this is the time to do it in order to generate support for the economy when it is weak. The growth it will generate will put the economy back into a positive cycle which will raise revenues from taxation again. The crucial mistake that Japan has been making for the last ten years is that they've been trying to spend their way out of trouble by pumping more and more yen into government programs. That has been shown not to work time and time again. The structural problems in Japan are also to blame. Tax cuts increase incentives in the economy and allow people to keep more of their own money which in a reasonably free and flexible economy will improve the long-term competitiveness and growth rate.

Contrast that with the situation in Europe where both monetary and fiscal policy are not helping very much. The European Central Bank is still obsessed with its 2% inflation target, while fiscal policy is actually counterproductive. At a time where growth is grinding to a halt politicians are planning massive tax increases in Germany in order to bring the budget deficit back down to under the 3% ceiling set in the Growth and Stability Pact. The deficit for 2002 is likely to reach 3.8% of GDP. And it's not just Germany that's in trouble with the Pact; France and Italy have also received a rebuke from the European Commission. The entirely situation is ludicrous but also sadly inevitable. The politics of the euro have created a situation which ties the Eurozone governments' hands behind their backs. They themselves are culpable too for not bringing their finances into order when times were good, but the problem is also that times weren't really that good in Europe in the 1990's. Nor in the 1980's. So the relentless momentum of the tragic euro-logic is tumbling ever onwards to a bigger crisis.

Things will come to a head one way or the other. The current situation was entirely predictable; at some point one of the Eurozone economies would end up with a deficit problem which then would need to be policed somehow. If it's a smaller country, then the big ones will twist its arm back into compliance. The European Commission can hand out hefty fines for countries which violate the rules of the Stability Pact. However with all of the big countries in the Eurozone now in violation (or being close to it) it's hard to see how any of this could be enforced or even imposed. The only reason countries would agree to pay any fines would be because of peer pressure. But with so many peers in similar problems, the peer pressure is going to be more of a gentle touch on the arm rather than the weight of a supertanker.

So a crisis will take place. Either the Commission refuses to impose fines on the violators, or the violators refuse to pay. Either way the very fabric of credibility which the EU has been trying weave for Monetary Union will be damaged. There is already substantial divergence in the EMU economies, and the odds are improving that we'll see a big crisis this year. I still don't think it's the most likely scenario, since the political capital that has been invested in Monetary Union is too big on all sides for it fall apart so soon. Some sort of economically nonsensical compromise will be reached.

Even as a crisis in EMU looms, the negative effects of the Stability Pact will still be felt in the Eurozone economies because politicians will trying to reduce their budget deficits. Even if they don't get the deficit fully into lines with the strictures of the Stability Pact, the effect on growth will still be negative at a time when Europe is desperate for growth. Of course, none of these short-term fiscal effects affect the longer-term structural problems of Europe, such as the rigid labor market, demographic troubles and lack of entrepreneurial spirit. Unless those problems start to get solved quickly, Europe's future is dismal.

The difference in response to slow growth on either side of the Atlantic is huge. The American authorities recognize the problem and are determined to avert them, even if this means storing up other problems for the future (inflation, for instance). It's the lesser of two evils, and a deflationary spiral in the US would be devastating for the world economy. In Europe the problem is compounded by the fact that EMU is a politically-driven creation that lacks fundamental economic legitimacy. With 12 governments each running substantially different fiscal policies (something the Stability Pact was trying to prevent) the ECB's already difficult task becomes even harder, especially considering the divergence that already exists in the economies. A fiscal blow-out in one of the bigger countries affects the entire Eurozone and there's not much anyone can do about that. The EMU could be seen as an another example of the Tragedy of the Commons. The euro is a common good that was supposed to bring lower interest rates and macroeconomic stability and credibility (for most countries anyway). This is a common good, but in order for it retain its beneficial qualities, the Eurozone countries need to exercise discipline. They're not doing so because why bother if you can get all the benefits without really having to maintain discipline? Unless the EU gets a united federal government (a prospect I dread), and one that can achieve real convergence in the economies without blowing itself up, then having a single monetary policy is going to remain highly problematic.