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Between a rock and a hard place

French prime minister Lionel Jospin wants to increase government spending. But the Bundesbank won't let France into Emu if its budget deficit rises. Unless one gives way, Emu is off. By David Roche.

Life under the euro

Financial markets are betting that European economic and monetary union (Emu) is still on track after France's new socialist prime minister, Lionel Jospin, accepted German chancellor Helmut Kohl's terms on the Stability Pact at the recent intergovernmental conference in Amsterdam. That convinced markets of the irresistible force of their combined political will to achieve Emu, despite the Paris-Bonn spat over "job creation" versus "sustained fiscal stability".

If Emu is indeed destined to go ahead on time, short-term interest rates will converge completely for first-wave members at the single discount rate set by the European Central Bank (ECB). Long bond yields will continue to converge to equilibrium spreads over Germany. And the euro (and the Deutschmark before it) will be a weak currency. This is what the market consensus seems to believe, and it's why financial assets continue to perform as if Emu is a done deal.

But I think this view could be dead wrong on two counts. First, the French may have signed up to "fiscal stability", but they have denounced "austerity". And their budget deficit looks set to overshoot the Maastricht criterion by some way.

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