Month: May 2012

At one level, the Fiscal Treaty is quite a limited shift in European fiscal arrangements, especially relative to the already-agreed six pack. (This short guide is a handy reference, while the sixpack details are here.)

The headline on today’s IT op-ed by Terrence McDonough suggests that it is riskier to vote yes than to vote no.  Since controlled macroeconomic experiments are not possible, there will inevitably be differences in such assessments across economists with different economic models of the world.

McDonough’s evaluation of the balance of risks is consistent with his broader analysis of the European crisis. For instance, as reported in the Irish Times in July 2011:

AN IRISH big bang involving debt default and withdrawal from the euro is needed to take the economy out of depression, the United Left Alliance national convention was told at the weekend.

Terence McDonagh, an economist from NUI Galway, told more than 400 delegates from around the country who attended the convention in Dublin on Saturday that five measures implemented simultaneously over a 48-hour period would reinvigorate the economy.

The alliance’s forum focused on its future and how it might develop into a national party.

Formed before the last general election, the alliance comprises the Socialist Party, the People Before Profit group and the Workers and Unemployed Action Group as well as some independent members.

Prof McDonagh said he wished to propose a radical economic programme to address the economic “depression”. He said the country should default on its debt, leave the euro, build a single public bank, provide a jobs guarantee for all workers and nationalise the Corrib gas field.

By 2014, the State would owe €200 billion, €80 billion of which was to bail out the European banking system, he said.

A further €80 billion was attributable to “the elite’s refusal” to tax itself. “Irish working people and poor people cannot pay, shouldn’t have to pay and sooner or later won’t pay,” he said.

Arguments against default suggested there would not be any money in ATMs or to pay nurses or bus drivers; the solution to this was to leave the euro and print our own currency. This would take us out of the “euro madhouse” and allow us to reinflate the economy.

The creation of a new public bank, taking with it assets of existing banks, would leave behind a bad credit bank owned by shareholders, bondholders and the European Central Bank.

“If the ECB believes the bondholders should not be burned, they can pay them first,” Prof McDonagh said, to a round of applause. The Government should provide a jobs guarantee and “command unused labour resources for the common good”.

It should also purchase and develop domestic energy assets, including the Corrib gas field, he said.

I imagine that voters that share this analysis will indeed be inclined to vote No.

The set of potential No voters is of course far wider than this cohort, just as the set of potential Yes voters surely encompasses a wide range of views on the prevailing economic model and the future of Europe.

The IMF is running a workshop on this topic tomorrow –  schedule is here.

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.

The economic logic behind fiscal rules has been a major area of research in recent years.  (The general philosophy behind the Fiscal Compact did not just emerge in recent months.)

In the Irish context, I have written a couple of pieces:

“A New Fiscal Framework for Ireland” (JSSISI 2010)

“Background Study for Oireachtas Joint Committee on Finance and the Public Services” (2010, Appendix)

The desirability of fiscal discipline for small open economies (especially inside EMU) is a long-standing research interest of mine. An earlier contribution is

“Irish Fiscal Policy under EMU” (Irish Banking Review 1998)

Many participants in the Treaty debate dislike the idea of legislation that relies on the concept of a structural budget balance. Certainly, there are measurement challenges with this concept and estimates of the structural balance will be frequently revised (which is one reason why the Treaty includes a correction mechanism when cumulative deviations from forecasts grow too large). Still, I have yet to see an explanation as to what is a preferred alternative, given that a target for the overall budget balance is intrinsically procyclical (during a recession, a given target is more difficult to achieve).

So, conditional on desiring a target for some measure of the fiscal balance, a target for the structural balance is preferable to a target for the overall balance.

This leaves the challenge of robust measurement of the structural balance (see also my piece here). In the spirit of the “excessive imbalances” procedure stitched into the six-pack regulations,  a nuanced approach is required that looks at a wide array of variables (GDP, credit growth, house prices, current account, competitiveness indicators) in order to assess the underlying structural macroeconomic position of an economy.  While the European Commission estimates will be an important benchmark, the special features of the Irish economy mean that local capacity to analyse and forecast structural positions will be important.