Category: Uncategorized

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. 

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:

To the surprise of exactly no-one the residential mortgage arrears problem has continued to worsen. The Central Bank’s Q1:2012 figures show that 116,288 accounts were either in arrears of over 90 days or had been restructured in some shape or fashion.

10.2% of private residential mortgage accounts were in arrears.

There are others, but right now two important (and updated) questions arise:

1. at what point will this growth in arrears begin to slow appreciably? As Jagdip and Carson in the comments point out, the rate has fallen off but clearly arrears levels are increasing at an alarming rate.
2. what projected effect will the proposed personal insolvency legislation have on these arrears going (ahem) forward?

Patrick Kinsella (no relation) writes on the Treaty in today’s Irish Times as the Taoiseach assures us the Treaty text won’t change. From Kinsella’s piece:

The Government is rigorously following the policies required by the troika of intergovernment lenders who support our current spending deficit and our bank rescue, and voting No will not change that. But the political situation in Europe is changing radically, and it is absurd to think that our partners will leave us high and dry for future loans because we reject a legal straitjacket on future policy demanded in the dying days of the Merkel regime. And don’t think the ideological rebalancing demanded by the fiscal treaty is limited to the euro zone members: the final article says “steps will be taken” to incorporate the substance of it “into the legal framework of the European Union”.

The political context for the social market economy in the 1950s and 1960s was the spectre of communism that haunted Europe. The context now includes the indignados of Spain, riots in Greece, and right-wing parties. Those of us with no great wealth other than our education worry for our children: where will they work, how will they live?

On this issue, the Labour Party in Government has abandoned its traditional constituency, signing up to support the banks at the expense of equality, jobs and fair working conditions. It has abandoned the social pillar of the European Union in the interests of an illusory “stability”. I sense that its traditional constituency will abandon Labour at the next election.

In the meantime, those of us who think that on balance the European Union has been good for Ireland, and do not want to see that balance overturned, have compelling reasons to vote No to this treaty.