Europe’s Fiscal Pact May Solve Next Crisis, Not This One: View
In concentrating on long-term fiscal reform and not the crisis at hand, the Dec. 8-9 European Union summit asked the wrong questions -- then failed to answer even those.
Financial markets won’t care as long as the leaders’ agreement encourages the European Central Bank to support EU sovereign borrowers more forcefully. Unfortunately, it may not.
The EU leaders agreed to write a new pact on economic governance to limit future budget deficits and public debt. It will not be a full treaty revision, which would need unanimity across the 27-member union, because Britain objected. This could be a blessing in disguise, because rewriting the EU treaty could have taken years.
Even this more limited reform, though, will take awhile to tie down. The deal calls for stricter enforcement of existing limits of 3 percent of gross domestic product for annual borrowing and 60 percent of GDP for total public debt. Exactly how these new, more automatic sanctions will work is yet to be decided.
The agreement also tells countries to write a “golden rule” into their basic law. Structural deficits -- after adjusting for the business cycle -- are not to exceed 0.5 percent of GDP. This, too, will need spelling out before it can be given legal force: Structural deficits cannot be measured; they have to be estimated using an economic model.
The golden rule is a bad idea anyway. To make room for fiscal stimulus in future recessions, countries would have to run big budget surpluses the rest of the time. This is too severe, and unrealistically so: Law or no law, it is unlikely to stick.
In the current emergency, EU governments rightly increased domestic spending and deficits. Germany, paragon of fiscal rectitude, ran a structural deficit -- the chronic shortfall that exists even when an economy is running at full potential -- of more than 3 percent of GDP last year. Far from being excessive, such a minuscule amount of fiscal stimulus was harmful to Germany and the EU overall. Nonetheless, it would have broken the golden rule.
Remember that, in a financial emergency, governments sometimes have to take others’ debts onto their books, as Ireland had to do last year when it was forced to bail out its banks. Structural deficits, therefore, may surge even if countries have little or no discretion to exceed the EU’s official limits. Striving to make the next crisis less likely by strengthening fiscal discipline is wise. Building a system that assumes there will never be another crisis is not.
In concentrating on long-term fiscal issues, the leaders mostly ignored the crisis around them. The lending capacity of the EU’s bailout fund was not increased, as some leaders had wanted. The subject will apparently be discussed at the next summit in March. A proposal for jointly underwritten euro bonds was likewise left for another time. That’s too bad. We continue to believe that collectively backed bonds are the best way to fend off future market attacks on highly indebted sovereigns.
The immediate question is whether the fiscal pact, malformed as it may be, will give the ECB cover to step up its bond-buying -- the outcome markets were hoping for, and the crucial next step in containing Europe’s financial crisis. First indications are discouraging. Mario Draghi, the ECB’s chief, told a news conference that too much had been read into his earlier comments, when he said the bank might follow a stronger fiscal union with “other elements.”
Let Draghi deny an automatic connection between the summit and ECB policy by all means -- so long as he acts, and quickly, to take charge of this emergency. One thing the summit has made clear: If he doesn’t, nobody else is going to.
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