Fiscal space should be widened in euro area
Doctoral Student, University of Helsinki
Online publication Future of Europe
© SOSTE Finnish Federation for Social Affairs and Health, February 2019
For the euro to function, a greater economic integration is required from the member states of the currency union. The euro crisis showed us the impacts of the lack of cohesion: it showed us the inner lack of solidarity in Europe, which has e.g. led to the spread of radical populism around Europe and laid foundation for xenophobia. If no remedies will be made in the eurozone, its systemic weaknesses will remain. This means that the eurozone requires strengthening of the fiscal framework to be operable when the next crisis hits.
European economic constitution and teachings of the euro crisis
The euro is a common currency of 19 countries without actual state backing.
It is a characteristic of the euro that the countries are nationally responsible for the finance policy and the European Central Bank (ECB) oversees monetary policy supranationally. The euro countries differ from each other not only economically but also culturally, and hence the countries of the Monetary Union cannot be regarded an optimal currency area. To operate, the euro requires economic harmonisation of the member states, for the euro is not flexible. This means the harmonisation of e.g. public finances, the labour market and capital markets.
Since no Treasury Department was created as a counterpart to the ECB, the creators of the euro hoped that the framework of the Monetary Union would lead to the harmonisation of the member states. Under the Stability and Growth Pact, the public deficits of the euro countries shall not be more than three per cent and the public debt more than 60 per cent in relation to the gross national product (GNP). Article 125 of the Lisbon Treaty also prohibits the joint liability of the debts of the euro countries, and Article 123 prohibits the funding of the member states by the ECB. Prior to the start of the fiscal crisis, President of the Finnish Republic Sauli Niinistö wrote the following on the framework of rules of the Monetary Union:
These rules were intended to increase the risks involved in funding the public sector in the hope that the finance markets would ”punish” finance policy that is not on a sustainable basis.¹
This did not happen, however. The economies of the euro countries did not become sufficiently harmonised after the Monetary Union was created. Only few of the euro countries fulfilled the rules of the Stability Pact, and the Commission did not have credible means to monitor adherence to the rules. Focus on the deficits left the huge surpluses of Germany unnoticed and led the development of the current accounts toward imbalance. The harmonisation of the interest rates also resulted in the huge indebtedness of the Mediterranean countries to the German and French banks.
During the euro crisis, there was a need to radically reinterpret the original legislation. During the second weekend of May 2010 – fittingly on the Europe Day – the first support package was granted to Greece. At the same time, a stability mechanism was launched and a day later the ECB announced the first public sector asset purchase programme. The lesson taught by the euro crisis was that the Monetary Union made it through the euro crisis by breaking its own rules. The second lesson of the euro crisis was that solidarity in the eurozone is conditioned to severe financial discipline and every euro of subsidy is earmarked. This lack of solidarity within Europe contributed also to open xenophobia toward the refugees coming from outside of Europe.
Rules have turned against themselves
Following the euro crisis and the refugee crisis, populist and radical parties have marched into the Parliaments of all European countries. When the euro countries have focused on their internal policies, the necessary reforms of the Monetary Union have remained inadequate and incomplete.
Populist and radical parties have marched into the Parliaments of all European countries – when the euro countries have focused on their internal policies, the necessary reforms of the Monetary Union have remained inadequate and incomplete.
Since it is not to be expected that a Treasury Department will be created as a counterpart of the ECB in the future, nor is it likely that there will be a big enough budgetary capacity in the form of a euro budget or stability mechanism, the member states should be given the opportunity to help themselves if the worse comes to worse. This can be carried out by simplifying and adding more flexibility to the budgetary rules of the European Stability and Growth Pact.
The problem with the rules is that they do not afford equal treatment to the euro countries and the monitoring thereof involves considerable judgement. When the Commission tried to intervene with the German and French deficits in the early 2000s, the countries vetoed the unpleasant decisions. While the Commission gives a tough time to Italy for its new budget proposal, it has allowed France, Spain and Portugal to break the rules.
In addition, the rules only take into consideration budgetary deficits. Compared to them, external imbalances are a bigger problem. The large volume of trade between the euro countries has resulted in huge surpluses for Germany and the situation that has arisen complicates achieving a balance of payments on current accounts. It is not intellectually sustainable that there is a punishment for deficits, when surpluses are celebrated.
During the first two decades of the euro, the rules of the Monetary Union have not fulfilled the criteria set upon them. They have even defeated the purpose, as they have led to an ineffective and partially inappropriate combination of fiscal and monetary policies.²
The prudential rules also prevented boosting the economies of the crisis countries, and due to the strict mandate of the ECB, a stimulus programme could only begin when the Monetary Union was close to a breaking point. In the United States, the administration and the Central Bank reacted immediately, making recovery faster. In Europe, the inappropriate economic policy caused by the rules of the Monetary Union has prolonged the euro crisis and heightened the social problems caused by it.
When we talk about completing the Economic and Monetary Union, and new euro reforms, it is a legitimate requirement to demand amendments to the legislation. This has been suggested for example by the Economic Councils of Germany and France, the International Monetary Fund (IMF) and most recently, the newly set up European Fiscal Board.³
The rules should be developed to accommodate the diverse needs of the growth cycles and recession. During periods of growth, budgetary discipline could be tighter, but when external shocks hit, a much greater economic flexibility than is presently the case should be allowed.
The rules should be developed to accommodate the diverse needs of the growth cycles and recession: during periods of growth, budgetary discipline could be tighter but when external shocks hit, a much greater economic flexibility than is presently the case should be allowed.
Germany cannot be forced to relinquish its surpluses, but rules could be amended e.g. by channelling investments to the European Investment Fund if the surpluses exceed three per cent.
Secondly, rules should not prevent public investments into fields which are necessary for well-being and economic structures. For example, investments in education, healthcare or other social flagship initiatives should remain outside the regulatory framework.
Finland has long opposed increasing fiscal solidarity in the Monetary Union. In the present political situation, reforming the rules is the easiest way to amend the Monetary Union without increasing fiscal solidarity and transfers. By amending the rules, more economic leeway may be given to the member states.
In the present political situation, reforming the rules is the easiest way to amend the Monetary Union without increasing fiscal solidarity and transfers.
If the eurozone is not amended, its systemic weaknesses remain. This means that the eurozone will be fiscally incompetent when the next crisis hits as well, and the ECB will be forced to take more responsibility again. It should be noted that the populist movements are popular even now, and when the next severe depression comes, their backing is unlikely to decrease.
Simplifying legislation is the aim of the European Commission, and it has also been supported by Finland. Amending the rules will be up for discussion next year, when both the general elections and the European Parliament elections will be held. Hopefully the NGOs and parties grasp this opportunity, for loosening the fiscal rules is the key to socially progressive reforms.
- Citation from the text by Sauli Niinistö & Johnny Åkerholm “Common currency – the beginning or end of European cooperation?”, which has been published in a book compiled by Alexander Stubb From the Margin to the Core. Finland in the European Union 1989-2003.
- Joel Kaitila and the author have examined the inappropriateness of the fiscal policy rules of the Monetary Union in more detail in the report From Financial Discipline to Autonomy; the Measures of the Euro Countries to Increase Leeway (in Finnish). https://vasemmistofoorumi.fi/uusi/wp-content/uploads/2016/08/ pdf
- The Economic Councils of Germany and France: https://www.ft.com/content/509ee376-b5d0-11e8-b3ef- 799c8613f4a1, IMF: https://www.imf.org/~/media/Files/Publications/DP/2018/45611-resdp-fiscal-union-in-euro- area-022118.ashx, The European Fiscal Board: https://www.euractiv.com/section/economic-governance/news/eu-fis– cal-board-blames-commission-of-ineffective-recommendations/
This is an article of the online publication Future of Europe.
© SOSTE Finnish Federation for Social Affairs and Health, February 2019