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There is a widespread opinion that the policy rules of the EU, and especially of the eurozone, trap its members in economic stagnation. In particular, the stability and growth pact, which constrains governments’ budgetary freedom, is thought to make the eurozone incapable of supporting weak aggregate demand sufficiently when monetary policy is stretched.
Free Lunch has argued, in contrast, that Europe can, and should, do more demand stimulus. That raises the question of whether the stability and growth pact frustrates this — if national governments that can spend more do not want to, and those that want to, are not allowed.
The answer lies with the European Commission and whether it takes its role as guardian of the European treaties more seriously. To see this, it is worth revisiting what the treaties actually say.
Consider the goals and purposes of the EU, as set out in Article 3 of the Treaty on European Union, which include “the wellbeing of its peoples”, “balanced economic growth and price stability, aiming at full employment and social progress”, to “combat social exclusion”, “promote social justice and protection”, and achieve “economic . . . cohesion”. Since the crisis, the EU has surely fallen well short on the measures of wellbeing, growth, social exclusion, and full employment.
Consider, too, the purposes of the economic and monetary union as well as the stability and growth pact, set out in Articles 119 and 120 of the Treaty on the Functioning of the European Union:
“For the purposes set out in Article 3 of the Treaty on European Union, the activities of the Member States and the Union shall . . . include a single currency [and] entail compliance with [principles including] sound public finances . . . Member States shall conduct their economic policies with a view to contributing to the achievement of the objectives of the Union . . .”
Finally, consider the purposes of the fiscal compact, which tightened the fiscal rules for the signatories, as set out in its Articles 1 and 2:
“ . . . the Contracting Parties agree . . . a set of rules . . . thereby supporting the achievement of the European Union’s objectives for sustainable growth, employment, competitiveness and social cohesion . . . This Treaty should apply insofar as it is compatible with the Treaties on which the European Union is founded”
One does not have to be a lawyer to detect a hierarchy here. More importantly it is politically essential that there be a hierarchy. The ends justify the means, not the other way round. And should the means be contradictory to achieving the ends, it is the ultimate ends that ought to prevail.
This, then must apply to the specific policy rules as well. Those include the 3 per cent deficit-to-GDP and 60 per cent debt-to-GDP “reference values” in the stability and growth pact, as well as the requirement of a structural fiscal balance and numerical rules for how fast budgets must adjust to the reference values when they deviate.
Those “reference values” do not appear in the treaty text proper; they are tucked away in an annexed protocol. The numerical rules in the fiscal compact are explicitly subordinated to the main treaties.
As guardian of the treaties, therefore, the commission should now own up to the contradiction between their goals and the specific application of the fiscal rules. It should assert its obligation to interpret the stability and growth pact in ways that best fulfil the treaty goals of full employment, growth with social cohesion, and fiscal sustainability.
Concretely, that could mean the following:
To acknowledge that the reference values for sound public finances may have been appropriate in the 1990s, but that equilibrium real interest rates have fallen significantly since then. If 60 per cent debt-to-GDP was sustainable then, a much higher level is sustainable now.
To redesign its technical methodology for determining the potential output of national economies, to remove the perverse feature that requires fiscal contraction in response to a slowdown in growth.
To acknowledge that when growth is below potential, fiscal contraction makes debt burdens heavier, not lighter, so that fiscal consolidation is counterproductive with respect to the very purpose of the stability and growth pact itself. Great public spending on investment is particularly conducive to sustainability.
To call for the right fiscal stance for the eurozone as a whole — which today means more expansionary policy — and explicitly commit to not punishing the countries that contribute to this common good.
And to follow the International Monetary Fund’s lead and encourage structural reforms that support short-term growth while discouraging those that weaken demand — and explicitly allow greater fiscal leeway to those that pick a better reform package.
Of course much of this would contravene the 3 per cent limit on deficits or the structural balance requirement. But honouring those limits would violate overall goals of the Treaties. When the law is contradictory, it cannot be honoured in full, and it is incumbent on the commission to emphasise which parts should take priority.
In a small way, the commission is doing some of these things — as its statement on flexibility shows. And in its recent actions, such as its judgments on Spain and Portugal, it has practised lenience. But this remains too timid, and indeed somewhat underhanded.
The commission could, and should, explicitly call for more expansionary fiscal stances. It has more power than before to do so, as its recommendations are binding unless overturned by a qualified majority of governments. It has the political legitimacy to do so, as commission president Jean-Claude Juncker was appointed after vowing to lead a more political commission. He should make good on that vow.
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