Euro Pills: How (Not) To Save the Euro

Commission’s proposals for fixing the Euro mess are numerous and involve a many
economic and legal problems. As for the latter, the trade-off is between
timeliness and effectiveness of the measures. More ambitious reforms require
amendments of the European treaties and therefore run the risk of being mired
in exhausting negotiations. I summarize below the main  proposals, and my take on these issues “in
pills”, referring the interested reader to links with more in-depth discussions.

1. Strengthen fiscal discipline by
lowering the threshold for excessive deficits from 3 to 0.5% of GDP
    Bad idea.
The problems in Europe, with the exception of Greece, do not come from
excessive deficits. They arise from non-convergence of productivity growth
rates and from the widening competitiveness gap between “North” and
“South”. Excessive fiscal deficits are largely the result of the international
recession. The problem of the ineffectiveness of the EU budgetary discipline is
not due to the fact that the 3% deficit/GDP limit is too high, nor to the low
credibility of the sanctions (which Germany and France have contributed to
weaken with their proposals in 2006). Reducing the deficit limit will result in
a deflationary bias at the EU level. The problem is how to introduce incentives
for debt reduction
for countries in cyclical expansion, such that they have the
possibility of running deficits in recessions, while not incurring in a secular
increase of the debt to GDP ratio. I have presented (at the  European Parliament) a proposal based on  “points”, similar to that for driving permits, such that a country can earn points with “good behavior”
(running budget surpluses, presumably in bad times)  and can “spend” points with “bad behavior” (running deficits, presumably in bad times), so that fiscal discipline over the business cycle does not prevent counter-cyclical policy (see here and here )

2. Automatic sanctions
, you could think of automatic penalties both in terms of fines, for
example a reduction of EU funds in proportion to the deviation or in terms political
sanctions, including the suspension of voting rights. The important thing is
that these penalties should apply to state contingent rules (for example, they should
refer to cyclically adjusted balances, see above)

3. Introduction of the balanced budget
rule in the Constitution
of the EZ countries.
. On the one hand the condition of a balanced budget is neither
sufficient nor necessary to ensure debt sustainability. On the other hand, the
experience with fiscal rules suggests certain skepticism about the
effectiveness of these rules: in general it’s the virtuous countries that put
these rules in their constitution, rather than the rules making countries virtuous (see here). Morover, the explicit criterion that
annual fiscal adjustment should occur in proportion (1/20) to the deviation of
the debt ratio from the 60% objective, is quite dangerous and will impart a
further recession bias to the EZ (see here)

4. The possibility for the European
Court of Justice to challenge the National Budget laws.

 Bad idea. This is a
surreptitious way to force the countries of the Euro zone to give up a share of their
national sovereignty. It’s likely to be ineffective and to produce a conundrum
of legal battles.  There are no
shortcuts: it is necessary to amend the Treaties, so that over time national
Parliaments devolve some powers to a European federal budget. My proposal is to
adopt a two-step budget process. In the first stage  the European Commission, say,
decides on the aggregate balances of the EZ member States, and in the second stage the
national parliaments choose the level and composition of revenues and expenditures
under the constraint established at the European level. I discuss the proposal further  in this interview with  Voxeu .

 5. Anticipating the entry of the ESM.
 It does not solve the problems
. The ESM, which is the
successor of the EFSF, suffers from a series of faults that this proposal does
not addresses:  a) the size of its budget
is insufficient (despite proposals to give the EFSF the ability to provide partial
insurance to new bond issues, or to introduce the possibility of securitization), even when the extre 200 billion to the IMF are considered;
b) the funding mechanism of ESM could propagate the crisis to countries in
difficulty, c) the voting rule make the local ESM hostage to tiny minorities.
Here the Commission allows for a qualified majority of 85% replacing unanimity
in case of emergency. Useful, but possibly not sufficient. d) The previous arrangements
for PSI had the effect of discouraging private investor by making current debt
issues junior in case of restructuring
(see here). The new rules improve by vaguely referring to “consolidated IMF practices” .