Let's recap events in Italy and France that led to this EU predicament.

In an unprecedented move on October 23, the EU Rebuked Italy's Budget. In response, Savini Threatened a Government Collapse and New Elections.

The EU demanded Italy reduce its budget deficit to 2.0% of GDP. Italy insisted on 2.4%. After the threats and counter-threats, the sides agreed to talk.

Note that France gets a deficit of 3.0% but Italy only 2.0%. This is because Italy's debt is higher. In practice, one ever honored any of these "stability pact" rules, including Germany.

Meanwhile, France just threw a wrench into the already clogged stability pact machinery.

In case you missed it, France Suspends Diesel Tax Hike over the riots. Then when that did not quiet the protests, I noted Macron Attempts to Placate Yellow Vest Protesters With Free Money.

The French deficit was 3.0% but thanks to the yellow vest riots, and Macron's response, the French deficit is now estimated to be 3.6%.

Free Money

Q. How did Macron accomplish his free money miracle?

A. By a "monthly government bonus".

Oops, that blows the budget.

With that backdrop let's tune into Eurointelligence for some color commentary.

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Stability Pact Overshoot

The spending promises from Macron's speech, together with the postponement of the carbon tax, imply about €11bn less money in the 2019 budget, according to Les Échos. And this is not the only financial fallout from the gilets jaunes movement. The Banque de France already slashed its forecast for Q4 from 0.4% down to 0.2% given the the impact of the ongoing protests on retailers. For next year the finance ministry expects €4bn less income due to lower growth figures, according to the paper's sources. This could push up the deficit to 3.6% of GDP next year.

Right after Emmanuel Macron’s announcement we noted an intense debate among our friends on Twitter on the impact a French fiscal overshoot would have on the eurozone as a whole. One commentator noted that Italy was now off the hook. It would indeed be hard for the Commission to push for an excessive deficit procedure against Italy while turning a blind eye to what is happening in France. Even Jean-Claude Juncker can only push the "because it is France" line so far.  

We also noted another debate on whether rules are only meant for small countries. The argument that you should accompany structural reforms with fiscal laxitude has its fair share of supporters in France and Germany. Germany famously overshot the 3% target in 2003 when it started the Hartz IV reforms. We heard one German economist making the same case for France now. This prompted the reaction that it would lead to disillusionment in smaller member states. A former Portuguese European minister predicted that this would totally destroy confidence in the eurozone.

France has not complied with the stability rules for many years, and it looks like that compliance is not becoming any easier politically.

So what we are seeing is a long-term erosion of the eurozone’s fiscal framework - a framework that lacked intellectual coherence from the beginning.

Macron has been the EU leader who expressed the most ambitious ideas for eurozone reforms - misdirected in our view but ambitious nevertheless. It is ironic that he is now on course to break the rules.

But make no mistake: Macron's fiscal decision is a very serious matter for the credibility of the stability pact, which the European Commission tried so carefully to rebuild after the crisis.

Pick Your Poison

The EU can crack down on France and Italy, or neither.

Imagine after these riots over taxes, the European Commission telling Macron to raise taxes or cut benefits.

Jean-Claude Juncker's comment "because it is France" will not float this time.

Mike "Mish" Shedlock

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