15 May 2018

VoxEU: Euro area reform: No deal is better than a bad deal

The instability of the euro area architecture is not due to a “poorly designed fiscal and financial architecture”. It reflects an unfinished building with a supranational monetary policy and 19 independent national fiscal policies. Thus, the only way to make it stable is to go ahead with political integration. This would allow a comprehensive debt mutualisation which would remove the specific insolvency risk of euro area membership. With the transfer of fiscal policy responsibilities to the supranational level, fiscal discipline of the member states would be enforced by a democratically legitimised euro area finance minister and not by myopic financial investors. In the current situation progress towards a fiscal policy integration is not very likely. But for economists this is not an excuse for not making explicit what is really required to stabilise the architecture of the euro area. 

For a productive Franco-German compromise, the German side must make a first step by allowing some flexibility concerning the ‘black zero’. This would allow more room for the golden rule in the Stability and Growth Pact so that at least a limited debt financing of public investments would be possible. As another step forward, one could envisage projects with large euro area externalities (infrastructure, defence, research, industrial policy, environment) which are financed by bonds with a joint liability. Finally, a thorough and open-minded analysis of the adequate targets for public debt to GDP would be very helpful.

CEPR Policy Insight 91 calls for “ashift inthe euro area’s approach to reconcile fiscal prudence with demand policies, and rules with policy discretion”. But it presents a framework that limits the scope for demand policies by the introduction of fiscal rules and “sovereign concentration charges”. And it reduces the scope for national policy discretion not only by the establishment of independent fiscal councils and but also by exposing governments to more ‘market discipline’. The proposal could indeed be a “game changer”, but into the wrong direction. 

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