Author: John McHale

After wavering for some time, Deputy Shane Ross has now publicly taken a No position on the Treaty. (See Sunday Independent article here.)   His position is that he is withholding judgement until he sees later growth-focused elements, and takes it that there would be another opportunity to vote on the complete package later. 

While this is a coherent position, I think it is worthwhile to stand back and recall the genesis of the fiscal compact.   The euro zone crisis was spinning out of control late last year, with runs on the sovereign bonds of Italy and Spain.  (The crisis has flared up again recently with the renewed uncertainties in Greece.)   It became ever clearer that the euro zone might not survive unless stronger mutual insurance mechanisms were developed.   Understandably enough, the euro zone countries most at risk of having to make positive net transfers under such mechanisms wanted some degree of assurance that all euro zone countries would follow reasonably disciplined policies, both to limit the expected value of the contingent liability and to minimise inevitable moral hazard.   Politicians in stronger countries also needed a degree of political cover in order to convince their electorates to take on large risks.  

For the most part, it was evident that stronger commitments to mutual discipline would have to lead that strengthening of the mutual insurance mechanisms, but the logic was clear.   In the event, the actual fiscal compact did not go much beyond what countries had already signed up to under the revised Stability and Growth Pact, but it did attempt to strengthen domestic ownership by introducing domestic enforcement mechanisms for the already existing structural balance rule.   Recent events in Spain have brought the possibility of more centralised bank resolution, deposit insurance and supervision onto the agenda as part of this process. 

An often heard complaint in the debate that the commitment to develop these mutual insurance (and related growth) measures are too vague – hence Deputy Ross’s position.    But it is interesting that where the linkage is made explicit – i.e. access to a scaled up ESM – it is considered a “blackmail” clause.  

Not surprisingly, the Treaty debate has ranged widely – the impacts of austerity measures, the implications for post-2015 fiscal adjustment of the existing SGP rules, the nature of additional commitments made under the Treaty, access to alternative sources funding if the Treaty is rejected, etc.   An unintended positive spinoff is that voters are now much better informed on fiscal issues – even if sick to the teeth from hearing about them.   But in the few days remaining before the vote, and with the euro zone again in turmoil, it is important to bring focus back to the core purpose of the compact. 

Advance warning: This post will only be of interest to those who have read the DeLong and Summers paper.

As has been referenced on this blog a number of times, the recent paper by Brad DeLong and Larry Summers has had a significant impact on the debate over optimal fiscal adjustment in a depressed economy.    Although the authors themselves note that the balance of arguments may be quite different in a non-creditworthy economy, the paper is still important to our debate (see also here and here).   

The key innovation in the paper is to incorporate the fiscal implications of potential “hysteresis effects.”  Put simply, these effects refer to long-lasting effects on future output – and thus on the future fiscal position – of fiscal adjustment measures today that reduce today’s output.   For example, the loss of a job due to weaker growth this year could have long-lasting fiscal implications if it makes it harder for the person losing their job to gain employment in the future. 

A striking conclusion in the paper is that, under what appear to be a relatively undemanding set of conditions, an expansion of government spending (or alternatively not engaging in some planned expenditure cut) could be self-financing from a long-term fiscal perspective.    Put another way, fiscal expansion could bring about improvement rather than disimprovement in a country’s underlying creditworthiness.  Thus, fiscal adjustment could be self-defeating from a creditworthiness perspective.   Given the influence of their argument, it is important to look closely at the assumptions that underlie this result. 

A Guest Post By Gavin Barrett

While I am second to none in my admiration of Vincent Browne for his willingness to engage with the legal issues raised by the Fiscal Treaty, I would have difficulties with some of the assertions made by him in his article in the Irish Times today.

1)      I am unable to see how the Pringle case (or any other case) can be the source of a legal threat to the Fiscal Treaty’s validity (as opposed to the ESM Treaty’s). The Fiscal Treaty is a normal intergovernmental treaty which the member states are perfectly entitled to agree with each other in international law.

2)      To my mind, the European Stability Mechanism Treaty clearly does not violate Article 3 TFEU. Nor does the Fiscal Treaty.  (Article 3 TFEU, as Vincent Browne correctly points out, confers exclusive competence on member states whose currency is the euro). The ESM Treaty has nothing to do with monetary policy. It sets up a permanent bailout fund to lend to member states in distress. The Fiscal Treaty also has nothing to do with monetary policy. As its name suggests, it has to do with fiscal (i.e., taxation and expenditure) policy.

3)      It is very far from clear that the Article 136 TFEU amendment process gives an opportunity to member states to veto the setting up of the ESM. It may be argued that it does, but it is not something I would bet the house on, much less the future of the Irish economy, which is what the ‘no’ side appear to want to do. The Referendum Commission does not support the view that there is a veto. Nor do the member states themselves, which will establish the ESM in July 2012 without Article 136 being in force. 

All going well, Article 136 TFEU should however be amended shortly afterwards by 1 January 2013. (Ireland, incidentally, has very little interest in vetoing this amendment, since it will put the legal basis of the ESM Treaty beyond any possible doubt. That is a good thing, since it looks increasingly likely Ireland will need to turn to the ESM for a second bailout in 2014.)

4)      I am unaware of any reason for questioning the use of the so-called Article 48(6) simplified revision procedure to effect the amendment to Article 136 TFEU.

5)       I am not aware of fundamental changes being planned for the EU’s structure which bypass procedures suitable for such change. The only one question mark that might be posed is in going ahead with the ESM Treaty without the Article 136 TFEU amendment. However, even if one took the view that the ESM Treaty should be supported by the Article 136 TFEU amendment, the latter amendment should follow its establishment within six months, then removing whatever doubt may be felt to exist in this regard.

Tom O’Connor sets out his views on the Fiscal Treaty here.   Seamus Coffey sets the record straight in a detailed response here.

Martin Wolf provides a cogent if sobering analysis of the euro zone crisis (FT article here; Irish Times article here).    I previously discussed the “impossible trinity” facing euro zone in posts here and here.   The euro is facing an existential threat; there are political limits to the possibility of a transfer union (including limits on potential net transfers under strengthened euro zone mutual insurance mechanisms); and the ECB does not consider a higher inflation/nominal GDP growth target as consistent with its price stability mandate. 

Martin Wolf describes the dilemma thus:

If dismantling the euro is out of the question, true federal finance is unavailable and mutual solidarity will remain limited, what is left? The answer is faster adjustment, to bring economies back to health. Indeed, that would be essential even if stronger solidarity were available. The euro zone must not turn the weaker economies of today into depressed regions, permanently supported by transfers, a policy that has blighted the south of Italy.

So how is faster adjustment to be achieved? The answer is through a buoyant euro zone economy and higher wage growth and inflation in core economies than in the enfeebled periphery. Moreover, the required growth strategy is definitely not just a matter of policies for supply.

According to forecasts from the International Monetary Fund, euro zone nominal gross domestic product will rise by a mere 20 per cent between 2008 and 2017. In the latter year, it will be 16 per cent lower than if it had continued to grow at the rate of 4 per cent achieved between 1999 and 2008 (consistent with 2 per cent real growth and 2 per cent inflation).

For the economies under stress, such feeble growth is a disaster: it means that the euro zone as a whole tends to reinforce, rather than offset, their credit contractions and fiscal stringency. They can blame the universal adoption of fiscal stringency and the policies of the European Central Bank, which let the money supply stagnate.

Something may give, and it is potentially disastrous if it is the euro.   The possibility of higher nominal growth targets needs to be part of the debate. 

On strengthening the mutual insurance mechanisms, the discussion in our Treaty referendum debate of the legal mechanisms to stop the ESM going forward borders on the surreal.   The purpose of the fiscal compact is to provide an added degree of assurance that euro zone members will pursue reasonably disciplined policies.   The idea is to give other members sufficient confidence (and a degree of political cover) to allow the mutual insurance mechanisms – probably eventually including some form of euro bonds – to develop.