What policy measures and economic governance reforms are needed to make the euro area viable?

The European Council is meeting in Brussels and crucial decisions are expected regarding both crisis resolution and medium-term reform of the euro area. A grand bargain is likely to emerge in which the ECB will do more to backstop euro area governments and reduce their borrowing costs. In return member states, at least in the euro area, will commit to some form of ‘fiscal compact’ imposing severe austerity measures on countries with high fiscal deficits and/or debts, and obliging all governments to sign up to some form of enhanced Stability and Growth Pact by, notably, anchoring debt brakes balanced budget rules) in national constitutions.

Such a package is inadequate in many fundamental respects. In particular it focuses almost entirely on fiscal consolidation via austerity, pushes the burden of adjustment onto the deficit countries while failing to address the key issue of intra-EMU competitive imbalances and, not least, ignores the need to boost growth in both the short and longer run.

This column sets out in outline form policy initiatives and economic governance structures that the euro area would need, in the short medium and longer run, to deliver sustained and sustainable, regionally balanced growth, low unemployment and price stability.

The short run

The euro area as a whole needs to be prevented from sliding into a renewed recession, which carries huge risks given already high unemployment and the strains on demand-side policy, and will make fiscal consolidation impossible. Avoiding this threat requires:

• An immediate cut in ECB interest rates to zero.
• The immediate provision of lender of last resort guarantees to euro area governments.
• Above and beyond that ECB commitment to delivering nominal GDP growth at least in line with trend (at least 5%) by means of unconventional monetary polices.
• Agreement on a fiscal stimulus package by countries with the fiscal room for manoeuvre together with a 12-month moratorium on additional austerity measures that reduce aggregate demand in deficit countries.
• Accelerated efforts by European authorities (EIB, Commission) to mobilise funding for infrastructure and other investment projects.

The medium run

The key medium-run challenges are (a) to unwind current account and competitive imbalances in a symmetrical way and (b) to ensure fiscal consolidation while resolving the moral hazard problem created by debt monetisation and mutualisation, and (c) underpinning faster actual and potential economic growth.Achieving such goals requires measures and reforms along the following lines:

For goal (a)

• Modeled on the existing Macroeconomic Dialogue (MED) for the EU as a whole, a MED should be set up specifically for the euro area (MED-Euro), with the participation of the European social partners, the ECB, the Commission, and representatives of the eurogroup finance ministers. It should be tasked with setting out symmetrical adjustment pathways for surplus and deficit countries involving, in particular, national fiscal policy and appropriate nominal wage-setting (a golden wage rule) based on strong collective bargaining institutions.

• The establishment of parallel national social-pact institutions, building on existing structures where appropriate, and involving national representative social partners, governments and central banks to decide on appropriate national adjustment strategies, in liaison with the MED-Euro.
• Monitoring of macroeconomic imbalances by the Commission, broadly as foreseen under the Excessive Imbalance Procedure, but with symmetrical regard to the problems of deficit and surplus countries and the relative nature of intra-EMU competitiveness.

For goal (b)

• To clear the way for necessary measures the Stability and Growth Pact in its current form must be set aside. The mandate of the ECB is to be clarified and broadened by having the inflation target set by the eurogroup/European Council (or replacing it with a nominal GDP target) and specifying more explicitly the goals of demand stabilisation and stability of the financial system.
• The swift establishment of a permanent fund to backstop member states and national financial systems by providing low-interest loans. However called (stability mechanism, monetary fund), it needs three key features: the ability to issue jointly guaranteed bonds and purchase government bonds, access to liquidity on request from the ECB, and the authority to impose conditionality on countries in receipt of support by the fund. Basic guidelines on conditionality must, though, be decided in advance by democratically legitimate institutions. In return the ECB will require greater institutionalised backing by euro zone member treasuries.

• As part of the European semester, the setting at the start of a year of an overall fiscal stance appropriate to the aggregate output gap of the euro area and recommendations for each Member State with a view to factors such as their specific output gaps and fiscal consolidation needs).
• As foreseen under the six-pack, the implementation of the agreed goals by Member States in national budgetary processes in the second half of the year, whereby the choice of tax and spend measures is left to national authorities.
• An agreement between all member states to avoid tax competition on mobile factors of production (e.g. minimum tax rates, a commitment not to reduce certain tax rates etc.).

• Under such conditions, the monitoring and sanctions regime envisaged under the six pack can be applied.

For goal (c)

• An expansion of the EU budget (or an additional budget for the euro area) financed by a financial transactions tax and/or carbon tax at EU27 or EA17 level, coupled with an ending of the obligation for the European budget to be balanced every year. Instead a medium-term balanced budget rule should apply, coupled with a management of limited annual deficits and surpluses by the stability mechanism.
• An expansion of those European schemes (infrastructure investment, cohesion funds) that contribute to economic growth and balanced economic development across the EU/EA.

The longer run

In the longer run a whole range of different measures is, of course, needed to strengthen Europe’s growth potential and stabilize and equilibrate growth, while rendering it also ecologically sustainable and socially inclusive. Ultimately a longer-term overall vision would be needed, but some priorities such as the following can be mentioned:

• Effective measures against tax competition and regulatory arbitrage (including joint action against extra-EU tax havens)
• Effective European-level supervision and re-regulation of the financial sector to address well-known problems (too big-to-fail, short-termism, taxation, credit-ratings, asymmetric information etc.)
• A coordinated increase in the effectiveness of national automatic stabilisers through benchmarking and target-setting (OMC), including automatic tax-rate adjustments, and asset-specific
• Support for multi-employer collective bargaining institutions in order to underpin the national MEDs.
• Continued expansion and strengthening of the Emissions Trading Scheme.
• Greater European cooperation in areas such as R+D, technology promotion, patents, a just green transition, etc.
• Establishing a European minimum wage norm as a proportion of the national average wage.
• Reorienting the structure of EU budget spending to current policy priorities.

Conclusion

The above is a brief sketch that seeks to stimulate debate. Each of the measures mentioned here requires further specification. Some are certainly more important, others perhaps dispensable. Some are more politically realistic than others. The point of setting them out in this way is to make clear just how large the gap is between what policy makers will agree upon at the current summit and what would be necessary for the effective functioning of monetary union.

If it is to function, the euro area needs debt mutualisation and a central bank acting as lender of last resort not only to the financial sector but also to governments. That implies greater economic policy coordination. On that all can agree. But if that coordination consists of blind austerity, debt brakes, and foisting one-sided adjustment on deficit countries the euro area will also not survive, nor would its survival be desirable. Unfortunately, this seems to be the course that Europe’s policymakers have agreed upon. Instead moves to enhance policy coordination should be developed in line with the principles adumbrated here.

1. How to bring Germany on Board and save the Euro