Re-thinking Euro Area Governance


The dysfunctionality of EA governance has been put into the public limelight as a result of its failure to overcome the 2008 financial crisis. Stagnant GDP, increased unemployment, excessive youth unemployment, widening income gaps, significantly higher debt ratios – plus a 3% current account external surplus are only the most glaring economic indicators. Separatist movements, widening fissures between Northern and Southern member countries, decreasing support of the EU as witnessed by deteriorating Eurobarometer numbers, the flocking of large electorates towards Euro and EU-inimical rightist parties, some with strong xenophobia – do we need more proof that in spite of a large number of new instruments both with respect to economic and fiscal policy and the financial sector the EU and especially the Euro Area are shown not to be up to the task of improving the lives of their citizens.

During the crisis, many new instruments have been installed to save financial stability in the EU countries: EFSF, ESM, the fledgling Banking Union, a host of new supervisory directives attempting to dampen risk taking by financial actors and to make the system more resilient were installed. The major flaw in the financial sector: no EU-wide or EA-wide „master plan“ was drawn up for how many and which banks are needed in Europe in the future; each country was left to deal with „its own“ banks, thus failing to sever the ties between sovereign and own banks, which – as a major cause oft he debt crisis – had been the intention of the Banking Union. As a result, very few banks were shut down as unviable, each country trying to „save“ its own banks and gain market share for them. Today, most banks are still under-capitalized and vulnerable.

The major fiscal policy tool, the Stability and Growth Pact, supposedly an instrument for coordination of EA fiscal policy, was „enhanced“, was accompanied by Two Pack and Six Pack, the Fiscal Compact, the European Semester and a number of other rules and monitoring mechanisms. The result is that no single EU finance minister understands it all and can comply with it (as the Governor oft he Banque de France François Villeroy de Galhau rightly remarked on March 22, 2016 in a speech at the Bruegel Institute). Only a small handful of Commission and national experts are able to see through the jungle of nominal, structural, Maastricht deficit definitions, the role of „potential output“ in budgetary planning and other hybrid indicators stacked on top of each other. Yes, a union of 28 or 19 needs a „rules-based“ approach towards policy coordination – but to create a jungle of parallel, frequently contradictory rules which follow a „one size fits all“ approach in the vain attempt to treat equally what cannot be treated equally, this is nonsense.

The strong tendency towards more national decision-making, towards regaining „sovereignty“ back from the EU institutions, is both a cause and a result of the failure of EU economic policy making and policy coordination. So far the EA has been unable to find a functioning balance between the needs to run an economic area of 19 countries, which requires this area to be a separate object of decision-making, and the individual circumstances of its 19 diverse, constituent countries. It is not enough to devise a desk-top solution to this task of coordination, but one needs to take account of the political acceptability of any solution. While up to now, mainly individual EA member states were the object of coordination and monitoring, the European Semester has introduced the Euro area economy as the primary object of its policy direction. For the EA as a whole a macroeconomic framework is designed, which then is supposed to be broken down to the constituent members‘ economies. Country-specific recommendations are drawn up by the Commission (up to 120 pages per country!!!) – which in the end, however, remain toothless symbolic attempts, testimony of the struggle between coordination and national sovereignty.

What needs to be done, in the face of the impossibility of installing the often called-for „fiscal authority“ or EA Finance Minister at the Euro Area level? It definitely does not make sense to heap another procedure (like the toothless and ill-defined Macroeconomic Imbalance Procedure) on top of an already convoluted, dysfunctional rulebook. The Euro Area needs both a drastic simplification of the whole fiscal framework, and an institutional set-up which combines Euro economy rules with national discretionary budgetary policies. This institutional set-up must have as its origin the fact that at each point in time, the macroeconomic needs of each member state will be different, that a one-size fits-all process does not work. We need to do away with Fiscal Compact, Stability and Growth Pact, MIP, and others – and start from scratch.

Two times a year, the macroeconomic stance of the Euro Area as a whole is analyzed by the Commission and discussed in the Euro Group. This then represents the Macro Framework to be also discussed with the European Central Bank, in order to determine the appropriate overall macroeconomic policy mix (fiscal/monetary) at the EA level. Member states take this framework into account in designing their own budgetary path, and notify this to the Euro Group. In an iterative process, the Commission tallies the national results, analyzes their compatibility with the desired EA stance, and, if not adequate, a deep discussion about possible adjustments by member states will follow in the next Eurogroup meeting. This process may take several iterations, until there is concurrence between the overall stance and that of the member states.

Such a process has two advantages (vis-a-vis the present process): a) it meets the political wish by members to determine their own budgetary stance (even if mitigated by Euro Area requirements); b) for the first time, it will lead to substantial discussions in the Eurogroup about the policy direction of the Euro Area (Up to now, the vast bulk of „discussions“ has consisted of talking about procedures, processes, indicators, etc, but not of substance). Of course, also this new process may not result in higher growth and less unemployment, may not be able to reduce the vast imbalances between member states, may also lead to policy failure. But it may result in bringing the different contexts in which members find themselves, into the open – and it will bring pressure on all members to promote both their national economy and that of the Eurozone as a whole in their planning process. A very positive side effect would be that the EU and the EA could eliminate the vast bulk of existing rules-based indicators, monitoring devices and legislation which today clutters the desks and prevents the revival of the Eurozone economy, and thus could concentrate on the primary task at hand, namely to run an optimal policy framework for a non-optimal currency area. And all this does not yet take account of the pressing wider sustainability Agenda, as outlined by the “Welfare, Wealth and Work for Europe” strategy developed by the Austrian Institute of Economic Research.



After this comment was finished, a paper on the same Topic by the Brussels-based Bruegel Institute ( came to my attention. The authors also criticize the dysfunctionality of the present fiscal framework in practice, mainly because of the unobservability and forecasting errors concerning the central “structural balance”, the large number of exceptions allowed, and also the fact that a number of countries just ignore the rules, no matter what Commission and Council say. The authors’ first-best option would be to scrap the whole Framework (which requires Treaty change) and subject the countries’ compliance to market discipline, in addition to establishing a fiscal equalization mechanism. They deem this solution politically unviable. Their proposed solution is to scrap all structural balance-related parts of the framework and adopt an expenditure rule with a debt-correction mechanism, embodies in a multi-annual fiscal framework. They would not set a Euro or EU-wide fiscal target, but are confident that their rule, if appropriately monitored by an independent “European Fiscal Council”, would generate enough fiscal space for each country to conduct, if necessary, counter-cyclical policies.

The paper is – as we have become used to from Bruegel – very well researched, empirically based and well argued. It hits a correct spot by eliminating the highly problematic structural balance as the main objective and replacing it by an expenditure rule. However, their proposal still required assessments and forecasts of “potential output” – which according to much research, is as problematic as the structural balance. Thus, their proposal does not go far enough in my opinion. I find it also problematic to delegate the monitoring and sanctioning to an “independent” European Fiscal Council – which would eliminate one of the major democracy-relevant policy areas, i.e. budgetary policy. Furthermore, their willingness to dispense with an Euro-wide determination of the Euro Area’s fiscal stance (and thus the attempt to set an optimal monetary-fiscal policy mix) ignores the fact that country-by-country policy might not result in an optimal policy for the Euro area as a whole. The proposal is certainly an improvement over the present chaos of rules, unobservable targets and large forecasting errors leading to erroneous policy advice – but it still retains some of the major original flaws of the present system



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Filed under Crisis Response, European Union, Financial Market Regulation, Fiscal Policy

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