Friday, 3 February 2012

Euro Deja Vu?

                I was giving a talk about the Euro crisis this week, and in preparation I looked at the new Treaty. Like Antonio Fatas I had that feeling that I had been here before. I remember reading the original Stability and Growth Pact (SGP) and wondering why the focus seemed to be entirely on debt ceilings, with no discussion of using fiscal policy as a countercyclical tool. Much the same could be said about this Treaty.
                To recap, this matters because there are two crises in the Eurozone at present: a debt crisis and a competitiveness crisis. General austerity might deal with the first, but because it includes austerity in Germany it makes the second worse: we have ‘competitive austerity’ that will lead to recession and will test the cohesion of the Eurozone. (For example, read Tim Duly and follow the links.) Both crises might have been avoided, or at least mitigated, if many non-German economies had undertaken much more aggressive fiscal tightening before 2007 as they saw their inflation rates exceed those in Germany. It is possible that the SGP itself may have discouraged such tightening, partly because politicians thought that if they were within the pact’s limits things were OK, and perhaps because of reasons I explore below.
                I cannot see anything in the new Treaty that encourages countries to think about their relative inflation and cyclical positions. If this Treaty had been in place in 2000 rather than the SGP, it seems likely that the crisis in competitiveness would still have emerged. Not only is the new Treaty unlikely to prevent such crises happening again, but it makes the current crisis worse, because there is no pressure on Germany to expand its economy by fiscal means.
                Is there anything positive to say about the Treaty? Maybe one thing. The idea of an automatic correction mechanism if deficits stray from the cyclically adjusted balanced budget rule is modelled on the Swiss and German debt brake idea. This mechanism has some attractions (see this paper by Charles Wyplosz), although I think the devil is in the detail. A debt brake with conditionality related to relative inflation rates might work, as some research I was involved with a few years ago suggests.
                The other big problem (besides ignoring countercyclical fiscal policy) which I have with the Treaty is the continuing emphasis on imposition ‘from above’. One thing that we have clearly learnt from the crisis is that it is in each country’s national interest to have adequate budgetary control. In contrast, a key idea behind the original SGP was that without it individual countries would free ride on the union, and that therefore union level control was required. This seems much less relevant today. The danger with control on individual countries coming from the union is that it becomes a ‘them and us’ game. If it is in the national interest to free ride at the union’s expense, then activities such as fiddling the figures may also be seen as in the national interest, when clearly they are not. If austerity is imposed from above rather than from within, the political dangers to the Eurozone itself are obvious. It would, in my view, be much better for individual countries to take ownership of the control of their own national budgets. This could be done through a combination of national institutional reform and nationally determined fiscal rules. Calmfors and Wren-Lewis (2011) show how this combination is becoming increasingly popular. I do not think forcing countries to pass laws to follow balanced budgets really qualifies as taking national ownership!

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