The night of Thursday 8 December saw a meeting to save the euro. Judging by reactions Friday morning, there is some way yet to go, but this column argues that Europe is getting there, slowly. A significant step has been made in the right direction; the principle is right but the details are missing.
This week’s Eurozone summit has taken two important steps. As always, however, these are laced with vagueness and reiterations of commitments to uphold previous failures.
The key achievement is the prominent decision that will require every Eurozone country to adopt a constitutional balanced-budget rule. Will that be enough to convince the ECB to act as lender of last resort? Maybe.
The second important step, which is irrelevant to the crisis, is the spectacular decision to adopt a ‘two-speed’ model in the EU. In a sense, this was inevitable given the size of the EU and being to an extent still shaped by its origins as a six-country undertaking. As it stands now, Britain has a financial model that emphasises the role of markets while the continent emphasises banks. A great deal of research has looked at the superiority of one model over the other without coming to concrete conclusions. It stands to reason that each country should be free to choose its model. This freedom of choice is also likely to concern other areas like taxation or labour markets.
With regard to the crisis, the beginning of the end requires three steps:
- A backstopping of sovereign debts by the ECB;
- A credible commitment to fiscal discipline over the next 50 years or so in order to reduce existing debts to comfortable levels;
- Debt restructuring.
The summit has moved seriously on the second step, which makes the first step more plausible but, unfortunately, appears to have backtracked on the third. As always, however, vagueness prevents us from drawing firm conclusions.
What is at stake at the current meetings is whether Europe’s leaders can offer the ECB the political cover that it requires to do its job without being seen as creating a moral hazard. The deal that is shaping up is that the ECB will ‘do something’ – but it matters a lot what this ‘something’ is. If governments manage to provide and keep a promise that unjustified budget deficits will no longer be the norm – as they have been in many countries over the last five decades – then that ‘something’ will be significant. In the Eurozone’s October summit, a little-noticed paragraph mentioned the need for each Eurozone country to adopt a balanced-budget rule. This has now become the first item of the December 8 statement. Unfortunately, it remains highly imprecise, so nothing may come out of it. But if it is done well, it promises to bring fiscal discipline to the Eurozone.
The Stability and Growth Pact and its latest manifestations have failed, and will fail, because they try to impose a centralised model of fiscal discipline, whereby the Commission tells sovereign governments what to do with their fiscal policies, threatening to impose improbable and counter-productive fines. The other model is decentralisation of the fiscal discipline obligation through national-level legislation that each sovereign country adopts and implements, following the model of American states. It has long been obvious that Europe looks more like the US than Germany, where the Laender have limited budgetary autonomy. At long last, this is now half-accepted. “Half” because national budgetary rules are now presented as the summit’s first decision, because the decision is imprecise, and because we still have countless references to a strengthening of the Stability and Growth Pact.
Balanced-budget rules are a reasonable response to fiscal indiscipline if they have sufficient built-in flexibility. The summit statement seems to refer to the German “debt brake” arrangement – borrowed from Switzerland. It is stated in terms of the cyclically adjusted budget, thus allowing for passive use of the stabilisers. And it seems to allow for temporary slippages, maybe mirroring the German-cumulated deficit account that must be closed ‘soon’. The risk is that other arrangements may be deemed acceptable, for example the French version, mistakenly called the ‘golden rule’, that is so complex and so imprecise that it invites avoidance through intentionally introduced loopholes. This means that the definition of what is a ‘good rule’ remains open, as is the monitoring of its adoption and enforcement. The summit indicates that it will rely on the European Commission and the European Court of Justice, but these institutions are only allowed to deal with EU-wide undertakings, not those that are limited to a subset of countries.
One potentially dangerous decision concerns debt restructuring, dubbed private sector involvement (PSI). The summit backtracks on an earlier decision that opened the door to this unavoidable step for a number of countries that are already over-indebted and that will have to rescue significant portions of their banking systems. At the same time it indicates that future public debts will include collective actions clauses (CAC), which are precisely designed to facilitate debt restructuring. This looks like a self-contradictory compromise between Germany, which wanted both PSI and CAC, and France which wanted neither. Presumably, the refusal of PSI will fold under market pressure and CAC will go through. This is all right, except that the CAC concerns future debts – presumably declining over time as fiscal discipline sets in – while the current crisis calls for the restructuring of existing debts.
The rest of the decisions are the usual fare of misleading and confused statements. This includes the automaticity of sanctions under the Stability and Growth Pact or the tinkering of funds under the EFSF and the ESM, which are too small anyway to deal with €8,900 billion of public debts. They include a bizarre arrangement to lend to the IMF funds that will be re-lent to the lending countries. Presumably, this is an invitation for other countries to enlarge the resources of the IMF. This is recognition of the debacle of the EFSF leveraging proposal, which amounted to asking poorer countries like China and Brazil to help out; these countries have made it clear that they would only lend through the IMF, where they expect some rewards in terms of governance. Another interpretation is that IMF loans are senior so that Germany would be reassured that its loans to Italy, for instance, would be fully repaid.
In the last analysis, the principal question that remains is whether the ECB will declare itself duly reassured of its political legitimacy soon enough to avoid a breakup of the Eurozone. The principle is there but the details are missing. If, as is likely, it will take some considerable time for the details to be agreed upon, the ECB may find itself forced to save the euro without the political cover that it is asking for. This is a good reason for the ECB to be cautious in its assessment.