Readers of this blog will know that I am an evangelist for fiscal councils. Fiscal councils are publicly funded independent bodies that provide analysis of national fiscal policy. (They are sometimes called ‘watchdogs’, but some – such as the CBO in the US or PBO in Canada – see themselves as serving the legislature rather than the public directly, so they flinch from that term. As some are not councils as such, but institutions with a standard hierarchical structure, then the term Independent Fiscal Institutions (IFI) may be better, but I use the term fiscal council on my webpage and elsewhere so I’ll stick to that.)
The good news is that in amongst the various directives/regulations/treaties that have recently been agreed by the European Union, there are clauses that encourage the formation of fiscal councils, together with the need for independent fiscal forecasting. (In some countries, like the UK, the fiscal council (OBR) is all about independent forecasting, while in others, like Sweden, forecasting was already reasonably independent before the council was formed.) This is a case of better late than never. Some EU countries have recently established fiscal councils through their own initiative as a response to the debt crisis (such as Ireland, Portugal and Slovakia), so this EU initiative is playing catch-up in their case.
The bad news is that the rest of the EU’s response to the debt crisis makes life difficult for these new fiscal councils, and may in effect hinder the formation of new ones. In essence this is because the broad thrust of the EU’s crisis management has been to take away national autonomy in making fiscal decisions. I complained about this in the context of the new treaty here. What I had not fully appreciated until recently is that you now almost need a fiscal council just to try and work out what the huge number of sometimes conflicting EU directives actually mean in terms of what a country is allowed and not allowed to do.
I think some economists view this development as benign, because they see it as part of an inevitable transition to a fiscal union. When others point out that so far it is no such thing, it is suggested that a fiscal union has to be done in stages for (largely German) political reasons, and that large scale European transfers will emerge once national fiscal responsibility is nailed down. Even if this was the planned pathway, I have severe doubts that it is a feasible path politically.
I have even greater doubts that the new European regime will be able to deliver fiscal responsibility. As I have often argued, simple rules that produce severely suboptimal outcomes are not sustainable. (For a recent discussion of this sub-optimality, see Karl Whelan.) This was true with the original SGP, and it is just as true now. The idea that you can have effective legally binding rules based on something as difficult to measure as a structural budget deficit is bizarre.
As Tyler Cowen suggests, a far better path would be one built on mutual trust. How can Germany begin to trust fiscal policymaking in other countries? Not, I would suggest, by placing monitors inside those countries – this is control, not trust. I far better way starts with recognition that it is in each country’s own interest to maintain fiscal discipline. The original Stability and Growth Pact was based on seeing fiscal policy as a free rider problem, where market discipline had been removed. We now know that this was a misreading, perhaps encouraged by a similar misreading by markets themselves. The pain caused by current austerity will linger long in the national memory. Once we recognise that debt responsibility is in the national interest, the aim should be to encourage the creation of national institutions that support that interest – national fiscal councils. These institutions can then be seen by other countries as their allies in maintaining fiscal discipline at the European level.
I fear the major barrier preventing this happening may be the European Commission itself. I remember attending a Commission conference soon after the Euro was formed, where I presented a paper that, among other things, explored the possibility of new institutions involved in national fiscal policy. I had a discussion with a senior Commission official, who thought this was an excellent idea - because the Commission could be that institution! Like any bureaucracy, the Commission is all about super-national control, and not subsidiarity.One recent episode is a case in point. The Commission has recently suggested withholding funds from Hungary because it believes that country has not taken sufficient action to control its deficit. Yet only a little over a year ago Hungary had a newly created and highly effective fiscal council under George Kopits. It was abolished by the Hungarian government largely because it was doing its job (for more information on this, see my earlier post). Where was the Commission then?