Towards a system to secure the euro

Eurozone governance appears to be focused on three aspects: strengthening of budgetary discipline; surveillance of the eurozone countries’ competitiveness; and provisions for crisis management. While this is a sensible agenda, Bruegel Director Jean Pisani-Ferrydelves into the details of these three topics to explain how they can work in practice. He also examines the inadequacies of the current institutional framework of the euro area and asks if it is time to seriously consider the creation of an independent surveillance authority.

Eurozone governance was for long a name without a game. The crisis, however, has brought clarity and, by common consent, discussions are focusing on three topics: strengthening of budgetary discipline; surveillance of the eurozone countries’ competitiveness; and provisions for crisis management. This is a sensible agenda. The failure of surveillance over the last 10 years needs to be remedied because, in spite of multiple procedures, it was markets, not peer pressure, that in the end forced adjustments. It needs to be rebalanced because the exclusive focus on public accounts distracted attention from bubbles in the private economy. And it needs to be complemented because the belief that crisis prevention made crisis management superfluous was proved wrong by events. However, the devil is in the detail. On budgetary discipline, the consensus in the European Council is that there is first and foremost a need for more sanctions. Yet the Greek disaster did not result from a lack of sanctions but from not checking the data reported. Ireland’s and Spain’s problems did not come from ignoring the EU’s stability and growth pact either but from the fact that it took no account of risk. When a country’s budget balance can move from a 2 percent surplus to an 11 percent deficit within the space of two years, sanctions that kick in when a three‐percent deficit threshold is crossed, or even before, are ineffective. What is needed is to stress‐test budgets and adopt a ‘policy‐at‐risk’ approach whereby buffers are adopted in proportion to the risks involved. A deeper problem is that top‐down budgetary discipline does not work. Countries flout the rules as long as they do not perceive them as national imperatives. Here, however, market pressure and Berlin’s decision to enshrine a budget rule in the constitution now combine to offer a chance for bold reform. Each government anxiously monitors bond spreads vis‐à‐vis the German Bund and looks for ways of reducing them. As suggested in a recent European Central Bank paper, the EU should grasp this opportunity, embrace decentralisation, and cut some slack for member countries equipped with home‐grown definitions of budgetary discipline, provided these are coherent with common aims. Such national rules need to be effective, but they do not have to be carbon copies of the German rule, because effectiveness depends on suitability to the country’s institutional context.
Competitiveness is second on the agenda. The European Commission was right to say that there is a need for better monitoring procedures. But the temptation will inevitably arise to copy the stability pact and define thresholds. Whereas the ‘traffic lights’ approach proposed by the ECB may help structure the policy discussion, a mechanical approach would be wrong. First, competitiveness and imbalances are multilateral in nature: it would be mistaken to ignore the fact that one country’s minus is another’s plus. Second, it is impossible to say what a ‘good’ deficit is, as all depends on how it is financed (eg by foreign investment or bank credit) and what its domestic counterpart is (eg capital expenditure or consumption). So thresholds cannot determine policy.
Rather, there is a need for authoritative, risk management‐oriented analysis of economic developments. Third, avoiding imbalances is set to become an additional objective in the eurozone, on top of budgetary discipline and financial stability. Serious thinking is needed on how all three combine within the overall policy framework. The third issue is crisis management and resolution. With the creation of the European Financial Stability Facility and the agreement on involving both EU institutions and the IMF in assistance, a big move has been made towards defining a crisis management regime. This is the good news. But as often pointed out by German observers, a policy system remains incomplete as long as the procedures for crisis resolution remain vague. To get the policy incentives right, the endgame needs to be specified. Now that the fiction of a no‐assistance system has been abandoned ‐ and rightly so ‐ the full definition of a crisis resolution regime is logically part of the reform agenda. This imperative should not be ducked.
The broader remaining question is the institutional one: how should Eurozone governance be organised? The crisis was indicative of the failure of procedures but also of the institutions in charge of surveillance and collective action in times of stress. The system now combines several institutions, none of which is in a position to take the reins: the Commission lacks the power it derives from the treaty in other fields like competition; the Eurogroup has consistently been short on foresight and initiative; the new Council Presidency is not designed to permanently specialise in Eurozone governance; French ideas for regular Eurozone summit meetings and a Eurogroup secretariat have been ditched; and whatever clout the ECB has gained from the crisis, it would be dangerous for its legitimacy to let it embark on mission creep. So the institutional question remains unsettled. This state of affairs is probably here to stay, which is not good news. At least, efforts should be made to create a moral authority with the ability to speak the truth and a chance to be heard. This is why the ECB’s proposal for an independent surveillance authority within the Commission deserves serious discussion.

A version of this op-ed was published in Financial Times.