What’s at stake: The European Commission will publish on Wednesday its concrete proposals on how to better coordinate economic policies in Europe going forward. Eurozone governments are moving gingerly towards an enhanced system of economic governance, uncertain how far they ought to limit national sovereignty in the name of saving their monetary union. More rigorous surveillance of national budgets, closer attention to debt levels and the development of a scoreboard to monitor trends in competitiveness were all agreed last week at a short summit of European Union leaders in Brussels.
Honor Mahony notes that there is a certain lack of clarity at the moment about what is meant by EU economic governance. Or to be more precise, everyone seems to know what France’s Nicolas Sarkozy would like. And it is relatively clear what Germany does not want. Beyond that, the lines remain unclear even though the phrase is bandied about freely. In brief, Paris has indicated it would like regular summits of eurozone countries, plus some permanent structures including a secretariat. A more politicised running of the 16 countries with the single currency. Berlin, mindful of the ECB’s independence, would rather keep all 27 member states involved. But an equally pressing concern is to ensure that the Greek situation is never allowed to happen again. This entails revising the euro rules to include greater prevention measures, surveillance and sanctions.
Ralph Atkins notes in the FT Money Supply blog that the ECB proposals for the future governance of the eurozone include the suggestion that a future European crisis management institution should be given powers to buy sovereign bonds to “address disruptions in markets”. In other words, if it got its way, the ECB would not have to take such steps again. Among the ECB’s other suggestions are that the possibility of a country being expelled from the eurozone should be ruled out “because the very existence of this option would put the viability of the common currency into question”. Overall, the ECB wanted “a more ambitious approach” than proposed by the European Commission. It favoured creating an “independent EU fiscal agency” and a “traffic light” system by which the “intrusiveness of surveillance” would increase for those eurozone countries facing the biggest competitiveness difficulties. Eurozone finance ministers would have increased responsibilities and together become “the guardian of fiscal sustainability”.
Strengthening the SGP
Tony Barber writes in the FT Brussels Blog that there are many flaws in the stability pact, but the essential problem is enforcement. How can outsiders compel a government, with sovereign control of its budget, to observe fiscal discipline? The pact contains a provision for imposing fines on countries that run up high budget deficits and ignore recommendations from other member-states and the European Commission to take corrective measures. Predictably, however, no country has ever paid a fine or has even been asked to pay a fine throughout the euro’s 11-year history. Governments have shrunk from punishing other governments because they know that the tables may one day be turned on themselves. Given the limited options for advancing fiscal policy integration that are available under the Lisbon treaty, EU finance ministers couldn’t have gone much further than they did in the Luxembourg agreement – EU member-states (and the Commission) will review each other’s draft annual budgets in spring, about six months before the spending plans are submitted to national parliaments. But sooner or later, more decisive measures will be necessary. To the essential problem of how to enforce common fiscal rules, the EU has yet to provide a convincing answer.
Michael Burda and Stefan Gerlach write that while the Stability and Growth Pact had good intentions, it failed because nothing happened when governments broke the rules. Their Vox essay proposes a 1% tax on new debt above the 60% debt-to-GDP ratio. Borrowing costs of Eurozone governments are currently artificially low because they do not reflect the bailout insurance implicit in Eurozone membership. A government that exceeds that limit by 50%, as Greece does today, would pay 0.5% of GDP per year. Such a surcharge debt does not infringe on sovereignty since countries could continue to borrow as they see fit. They propose that tax should be imposed on new debt only. As an illustration, Greece’s public is about 110% of GDP with an average maturity of 7.7 years. If debt of 14% of GDP is rolled over each year, it will take four years and three months before the 60% of GDP limit is reached and the surcharge applies. In the following year, it would issue 14% of GDP in new bonds and pay 0.14% of GDP in charges. Once all the debt has been rolled over, the full surcharge will apply. Such a mechanism would redistribute the costs of running Europe from the countries that have their house in order to those that don’t.
The Economist’s Charlemagne writes that the only discussion out there turns on exactly what sort of sanctions should be slapped on countries that misbehave. The Brussels consensus is that future crises in the euro must, absolutely must, be avoided with the help of new systems to oversee national budgets, and tough new sanctions for countries whose borrowing and spending looks unsustainable. As always with a Brussels consensus, the grip of these arguments on public debate is total. Some talk of fining countries by withholding EU funds. Others talk of suspending the voting rights of miscreants at EU meetings. Some think both might be a fine idea. But sanctions are apparently the way forwards. But the author reports that a large range of people from across the machine do not put their faith in this talk of sanctions. Some, to be fair, think that all is not lost because market discipline and peer pressure could still do a lot of good to improve public finances across the block. But sanctions? Nope.
Numerical fiscal rules or independent fiscal policy councils
Charles Wyplosz argues that Eurozone governments should not waste time trying to strengthen the Stability and Growth Pact. Strengthening means adding sanctions but sanctions cannot be really imposed on democratically-elected governments. The solution is to go back to basics. We absolutely need to establish, once and for all, fiscal discipline in every Eurozone country. Restoring fiscal discipline therefore requires Europe to tackle this political failure head on by adopting institutions that bind the budgetary process. There are many possible approaches, as shown in Von Hagen and Harden (1995) and Wyplosz (2002). It well may be that – given history and local politics – different countries need to adopt different solutions. A good precedent is last year’s decision by Germany to write into its Constitution the interdiction for the structural deficit to exceed 0.35% of GDP.
Antonio Fatás and Ilian Mihov write that the inability of governments to maintain fiscal discipline is not new. Their Vox essay argues that numerical budget rules are a far from optimal solution. They cannot be enforced and can produce highly procyclical policy during downturns. Additionally, many numerical constraints on deficits tend to be completely ineffective in generating the necessary surpluses during good years. For example, most of the EU economies saw their budget balances hovering just slightly above the -3% limit during the expansionary years from 2004 to 2007. Their view is that effectiveness requires an element of independent judgement. Constraints on fiscal policy need to ensure discipline while allowing for the flexibility (and feasibility) of the entire fiscal policy framework and over the entire business cycle. This is what we call constrained discretion. It differs from rules because it allows for discretionary decisions, but it provides the necessary checks and balances to ensure sensible policy in the long run.
Philip Lane argues that the scope of fiscal stabilisation policy needs to be expanded to recognise that fiscal sustainability is sensitive to boom-bust cycles in asset markets and balance-sheet fragility in the banking sector, other private sectors, and the external account. The optimal fiscal surplus during good times should be determined by examining the sectoral composition of output in addition to the overall level. In addition, a nation’s fiscal stance should take into account financial and external imbalances that may be accumulating in the economy. This wider scope for fiscal stabilisation policy reinforces the importance of designing a fiscal policy process that benefits from the substantial input of fiscal, macroeconomic, and financial experts. It is very difficult for political systems to make robust judgements on the appropriate cyclical stance of fiscal policy without an explicit role for expert input. To this end, an independent fiscal council can help identify the stabilisation risks facing the economy, estimate the appropriate cyclical position for the annual budget, and estimate the optimal future path of fiscal balances that will ensure fiscal sustainability.
Towards a political union
Paul De Grauwe argues that the eurozone lacks the mechanisms needed to ensure convergence of members’ competitive positions and to resolve crises. He argues that the survival of the Eurozone depends on its capacity to embed itself into a political union. The latter must imply some transfer of sovereignty in macroeconomic policies and the organisation of automatic solidarity between member states. Charles Wyplosz disagrees and notes that a meaningful government of Europe will not emerge soon as EU citizens are not now willing to give up much sovereignty. The disastrous saga of the Constitutional Treaty and the painful ratification of the Lisbon Treaty show that, very sadly, this is not the time for bold European undertakings.
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