The Fiscal Treaty and the Future of Europe
This post was written by Philip Lane
The Fiscal Treaty debate (at a European level, in addition to the Irish-specific context) should be understood in terms of a wider set of reforms that are important in improving macroeconomic and financial stability.
- Public debt levels after this crisis will be a high level in many European countries. This can be destabilising in itself (vulnerability to rising interest rates; general debt overhang issues) and also makes it more difficult to provide public support to deleveraging problems in the private sector (households, banks, etc). Fiscal rules that are implemented in a ‘cyclically-sensitive’ way can be helpful in providing a mechanism to guide the gradual return of sovereign debt levels to safer territory
- High public debt and high deficits are a barrier to the development of a truly European banking system (including European-level bank resolution funds), in view of the capacity of sovereigns to extract funds from local banks. (This is a two-way process - much more should be done already to delink banks from sovereigns, so some elements of banking union can happen in parallel with the adoption of the fiscal treaty but more extensive reform would be facilitated by lower national debt levels.)
- There are many flavours of eurobonds being discussed. I am not aware of any proposal that does not require substantial fiscal discipline at national level, in order to mitigate the moral hazard risks associated with common bond schemes.
- A larger European central budget would facilitate joint fiscal stimulus schemes during downturns. National governments are more likely to yield revenues to a central budget if national fiscal positions are stable.
- National fiscal positions are more vulnerable inside a monetary union (no national currency, elastic investor base for national sovereign bonds), so that a safety net of official funding (EFSF/ESM) provides important assurances that a country has backstop funding in the event of a crisis. Again, national fiscal discipline means that backstop funding can be reserved to deal with shocks rather than fiscal malfeasance.
So, the Fiscal Treaty provides one pathway to a more stable European system. The debate about the relative merits of ‘rules’ versus ‘discretion’ in policymaking will always be ongoing but an intelligently-applied rules-based framework can be an important element in the reconstruction of the euro system.