What is not in the Fiscal Compact?

At 1,395 words, Title III of the Treaty on Stability, Coordination and Governance is a very short document by official standards.  The Fiscal Compact contains just six articles and 11 paragraphs.  Understanding what is in the Fiscal Compact should not be difficult but there continues to be significant misrepresentations of the what the provisions actually mean.

As a response to the causes and consequences of the current crisis the Fiscal Compact is wholly inadequate.   From an Irish perspective it is true that “had the the Fiscal Compact been in place since 1999 it could not and would not have prevented the crisis in Ireland”.  It is possible that, in the run-up to the crisis, a greater adherence to the rules across Europe would have created some additional fiscal space to deal with the downturn but this leniency did not cause the crisis.

As regards the ongoing policy response to the crisis, the Fiscal Compact will make little difference.  At present 23 out of the EU27 (and 13 of the EZ17) are in the Excessive Deficit Procedure so even if the Fiscal Compact is torn up it would not lead to a significant change in policy.

However, when assessing whether the crisis could have been prevented it is important to realise that the Fiscal Compact only covers some aspects of the EU framework on economic policy. For example, the Compact does not mention the 3% of GDP overall deficit limit that was introduced in the Protocol on the EDP in the Maastricht Treaty.

The Compact also excludes some elements of the ‘Six Pack’ introduced last year.  From an Irish perspective, two additions worth considering are:

  1. A Government Expenditure Rule
  2. A Macroeconomic Imbalance Procedure

The government expenditure rule is included in Council Regulation 1175/2011 and specifies that:

for Member States that have achieved their medium- term budgetary objective, annual expenditure growth does not exceed a reference medium-term rate of potential GDP growth, unless the excess is matched by discretionary revenue measures;

Even though the Commission’s estimates of potential GDP growth at the time meant they estimated that Ireland was running a structural surplus, the potential GDP growth rates were not large enough to allow for the increase in government expenditure that took place since 2001.  Here is a table that retrospectively applies the rule to Ireland.  Larger version here.

 

From 2000 to 2007 the adjusted measure of government expenditure used by the rule increased by 130% and always exceeded the annual growth in nominal GDP and the 10-year average potential growth rate used as the benchmark in the rule.  If applied, the rule would have limited the increase in government expenditure over the same period to less than 50% “unless the excess is matched by discretionary revenue measures”.

The weakness of deficit and debt targets that are presented as a proportion of GDP is that they can lose their effectiveness in times of strong growth.  The new government expenditure rule is an attempt to address that.

The Macroeconomic Imbalance Procedure (MIP) comes from Council Regulation 1174/2011 and Council Regulation 1176/2011.  The latter regulation sets the process for the detection of imbalances and provides some details on their correction, while the former lays out the sanctions and fines that may be incurred if steps are not taken to correct the imbalance. 

The MIP attempts to broaden economic surveillance beyond the limited sphere of fiscal outcomes as it was imbalances in the overall economy rather than problems with public deficits and debt that precipitated the crisis in countries such as Ireland and Spain.

A scorecard of ten macroeconomic indicators has been devised and each of these has been assigned some threshold values.  The details of the procedure and the underlying documents are available here.  Karl Whelan has written a useful briefing paper on the MIP with particular focus on current account imbalances.

If applied retrospectively here is the scorecard for Ireland for the ten years up to 2010.  A larger version is here.

In 2002, Ireland was exceeding three of the thresholds.  In 2004 this increased to four and from 2005 Ireland was in excess of five of the thresholds.  The external imbalances were the real effective exchange rate, nominal unit labour costs and a declining export market share from 2006.  The internal imbalances are unsurprising and these were real house price growth, the increase in private sector credit and the stock of private sector credit.

We cannot be sure what would have happened if the MIP had been in place and the scorecard is not “applied mechanically”.  There is also a supplementary set of 18 indicators that is used.  However, given the persistent nature of the imbalances in Ireland (albeit measured by somewhat arbitrary thresholds) it is likely that the procedure would have been activated. 

As the MIP has yet to be applied in practice it is hard to know what this would have entailed.  According to the regulations, countries that are subject to a Macroeconomic Imbalance Procedure are required to produce a ‘Corrective Action Plan’.

Any Member State for which an excessive imbalance procedure is opened shall submit a corrective action plan to the Council and the Commission based on, and within a deadline to be defined in, the Council’s recommendation referred to in Article 7(2). The corrective action plan shall set out the specific policy actions the Member State concerned has implemented or intends to implement and shall include a timetable for those actions. The corrective action plan shall take into account the economic and social impact of the policy actions and shall be consistent with the broad economic policy guidelines and the employment guidelines.

The content and format of the corrective action plan are yet to be published.

Neither the government expenditure rule nor the Macroeconomic Imbalance Procedure would have been absolute in preventing the crisis in Ireland.  However, the expenditure rule may have resulted in a stronger fiscal position while the imbalance procedure might have seen the introduction of policies which would have attempted to curb the excessive lending that was provided to the property sector.

It is hard to know what impact these measures might have had on the spending decisions of politicians or the lending/borrowing decisions of private citizens.  The Fiscal Compact would not have prevented the crisis in Ireland, but the broader changes in economic policy at EU level do attempt to address some of the causes.

10 thoughts on “What is not in the Fiscal Compact?”

  1. An early warning system: an alert system based on an economic reading of a scoreboard consisting of a set of ten indicators covering the major sources of macro-economic imbalances is planned for ‘six pack’ monitoring.

    The European Commission says the composition of the scoreboard indicators may evolve over time. The aim of the scoreboard is to trigger in-depth studies which will do deep dive analyses to determine whether the potential imbalances identified in the early-warning system are benign or problematic. The Commission can organise missions, with the ECB if appropriate, to conduct the in-depth reviews which shall be made public.

    Irish annual credit growth moving towards 30% during the boom and the acceleration of private sector debt would have been tracked.

    Planned six pack scoreboard :

    3 year backward moving average of the
    current account balance as a percent of GDP, with the a threshold of +6% of
    GDP and – 4% of GDP;

    net international investment position as
    a percent of GDP, with a threshold of -35% of GDP;

    5 years percentage change of export
    market shares measured in values, with a threshold of -6%;

    3 years percentage change in nominal unit
    labour cost, with thresholds of +9% for euro-area countries and +12% for
    non-euro-area countries.

    3 years percentage change of the real
    effective exchange rates based on HICP/CPI deflators, relative to 35 other
    industrial countries, with thresholds of -/+5% for euro-area countries and
    -/+11% for non-euro-area countries;

    private sector debt in % of GDP with a threshold
    of 160%;

    private sector credit flow in % of GDP
    with a threshold of 15%;

    year-on-year changes in house prices
    relative to a Eurostat consumption deflator, with a threshold of 6%;

    general government sector debt in % of
    GDP with a threshold of 60%;

    3-year backward moving average of
    unemployment rate, with the threshold of 10%.

    UBS, the Swiss bank, applied the scorecard to EU countries: Austria get a rating of 8/10; Ireland is below Greece.

    http://www.businessinsider.com/ubs-fittest-countries-europe-2012-2?op=1

  2. Excellent post.

    The thing is. we knew at the time what was going on. The benchmarking insanity and the election cycle (note the pattern of excess expenditure growth in the first table).

    What’s not in the fiscal compact is what would have dealt with co-opted unions and an electorate dulled by the appearance of boom.

  3. Yup excellent post.

    Fiscal Compact recieving disproportionate attention due to the referendum whilst other measures Europe has taken over the past couple of years are not receiving the attention they deserve in the context of the FC debate.

  4. It’s unfortunate we do not have the excellent John Bowman’s Question Time anymore. RTE have made a very poor effort at bringing economic matters in FC to the public. In general, there are well informed people in Ireland across the professions who are interested in Public Broadcasting Network topics of this kind.

    The problem with the data here is the cuda, wuda, shuda. Its too late to bring good husbandry to economic theory in a new situation of fiscal meltdown where the game has changed so much. The periphery has bush fired out of control and the tall grass requiring new rules no longer exists.

    Those rules were largely ignored by the periphery. You can introduce as many six pack, 2 pack or FC rules as you want to run the neighbourhood; but, if the neighbourhood is so severely damaged that its population has fled, it is insolvent and bankrupt, then you need to throw out the rule book.

    Unfortunately, led by Germany in the main, austerity blindfolds are handed out with austerity rulebooks based on the above, ignoring the uselessness of such rules in the grim fact of debt burdens that are too big to carry, rules or no rules.

    We need another set of rules bringing debt to gdp ratios to manageable levels of 100%. These rules will require debt writedown. Until we have those, we got cuda, wuda, shuda, nothing more.

  5. I think we all agree that the economics of the Fiscal Compact are somewhere between not provably beneficial to provably harmful so these measures of economic imbalance seem more useful by comparison.

    In particular they acknowledge that it is not much use having a strict set of rules for government economic policy if the private sector does not have similar rules, especially if the state is expected to pick up the pieces after a crisis in capitalism on the scale of the one we are witnessing.

    Remember that the European component of the global financial crisis is primarily a failure in the financial markets which has contaminated states budgetary positions due to EU institutional preferences and the political leverage of Germany.

    A problem for those on the left is that the planned vast edifice of technocratic economic measurement and control as envisaged by the the EU is still poisoned by a pro-market, neoliberal mindset:

    for Member States that have achieved their medium- term budgetary objective, annual expenditure growth does not exceed a reference medium-term rate of potential GDP growth, unless the excess is matched by discretionary revenue measures;

    It envisages an economy where the private sector always grows more than the public one, a bizarre position where the lesson of the last ten years seems to be that the private sector is failing badly way as a method of allocating resources.

  6. wake up, we’re driving
    it’s best to keep moving
    things are going ok
    eating fruit on highways

    trying to stay healthy
    dreaming of the old days

    I saw kids running out in the fields
    the life of the farmer, it always appeals to me

    i wrote on a postcard i may or may not send
    i was keeping distracted until i saw horses and thought of you

    just put your arm around me
    smoke rising in the distance
    i wont sit in confusion
    its time for rebuilding

    hey rory hand me a lemon
    its good for hangovers and
    pass around the ginger
    it brings us together

  7. @seafóid

    In response, the new Spanish national anthem:

    Sell !

    Sell everything !

    Sell it now !

    We are toast !

    Long live our bankers !

    We are ‘in a difficult position’ !

    (Venta! Venta de todo! Vender ahora! Somos una tostada quemada!! ¡Larga vida a nuestros banqueros. Somos ‘phuqued’!!!)

  8. @Seamus Coffee
    You quote this from Eoin Ó Broin

    “Article 9 gives the European Court of Justice the power to impose fines of up to €160 million on states deemed to be in breach of the rules.”

    and you comment this,

    “It is actually Article 8 which deals with the powers granted to the European Court of Justice. The ECJ has no jurisdiction to rule on whether a country is deemed to be in breach of the fiscal rules. All the ECJ can adjudicate on is whether a country has adequately provided for the balanced-budget rule and a national correction mechanism in national law. This legal issue is the only thing the ECJ has jurisdiction on. The ECJ cannot impose any fines for breaches of the fiscal rules.”

    On Nama Wine Lake Gráinne M. Clarke in her Analysis of the fiscal compact writes

    “6. ARTICLE 8 (2): This paragraph means that if a country is brought to the European Court of Justice, and the country does not comply with a judgement made against it, that any other Euro area country can bring that country back to the European Court of Justice and request that financial penalties be brought against it. If the European Court of Justice finds that the defendant country has not complied with the judgement – the Court can impose a financial fine on the defendant country”
    http://namawinelake.files.wordpress.com/2012/05/esmfcanalysis.pdf

    Is one of you wrong or both right and I’m missing something

  9. @ Brian

    Both statements are correct. The ‘Gráinne M. Clarke’ is 100% correct but it never says what matter can be brought before the ECJ.

    At the Ard Fheis on Saturday, Eoin O’Broin said that countries can be brought before the ECJ for being “in breach of the rules”. That is not correct. The only thing in the Fiscal Compact that can be brought before the ECJ is whether a country has transcibed the rules from Article 3(1) into national law. If they haven’t the procedure as described in the second statement can occur.

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