“Triple-knot” fiscal safety for the Eurozone

Hans Gersbach 08 September 2011

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To ensure its own viability and the long-term wellbeing of its citizens, a monetary union does not have to be a fiscal union. But it does require some common line of fiscal action.1 As we have seen, the line of action taken up to now is failing to produce results. Without swift – and fundamental – institutional reforms of the Eurozone, our chances of resolving the current debt crisis and avoiding future incidents of the same nature are slim (see for example Pincus and Robinson 2011). It is, however, unclear what kind of rules should be chosen and implemented (see for example on this site Buti and Larch 2010, Cooley and Marimon 2011, De Grauwe 2010, Gersbach 2010a, Manasse 2010, Suarez 2011, and Wyplosz 2010).

The institutional approaches that have been suggested to help restore fiscal safety in the Eurozone range from centralised fiscal policy, temporary financial assistance through the European Stability Mechanism and strengthening of the Stability and Growth Pact to cementing the credibility of the no-bailout rule (see Fuest 2011).

With the exception of the fiscal union approach, all reform packages negotiated at European summits this year feature the last three elements. But there is considerable uncertainty as to how much can and will be done to make the no-bailout threat more credible. This threat is directly linked to the credibility of orderly bankruptcy procedures for banks and countries in the case of crises.

While the current move to introduce new institutions in the Eurozone may indeed foster a sense of fiscal responsibility, such institutional structures would be of greater complexity, and the enforcement of their decisions might also prove difficult.

In this column I want to outline an alternative institutional framework that would provide taxpayers with better control rights in connection with budget deficits and public debt in the Eurozone. In addition, this framework might in fact ultimately stiffen the Eurozone's democratic backbone.

The proposal

  • If the budget deficit (and the corresponding debt level) planned and adopted by a given country exceeds a critical threshold, this draft budget will require parliamentary approval from a subset of other Eurozone countries.
  • Rules would have to be developed to determine which countries get to vote on the budget of a given country. Eligibility for this role might hinge on a record of conservatism in fiscal matters or simply on the size of the Eurozone countries in question.

I call this procedure “Reciprocal Parliamentary Approval”.2 Refinements of the proposal are conceivable and may even achieve a better balance between national fiscal sovereignty and the limitation of public debt accumulation. We might for example imagine two thresholds for budget deficits, say 2% and 4% of GDP, coupled with a debt level of, say, 60% of GDP.3 If the debt level is below 60%, fiscal plans will not need approval from the parliaments of other countries. Suppose, however, that a country's debt level has exceeded the critical threshold level. If the budget deficit is below 2%, this country will need no external parliamentary approval. Between 2% and 4% it will need backing from two other parliaments. For very high budget deficits, i.e. above 4%, it would need the approval of four external parliaments.

Reciprocal Parliamentary Approval would be an advantageous substitute for the rules envisioned in the reform of the Stability and Growth Pact.4 Although subject to external parliamentary control, fiscal sovereignty would remain at a national level.

Main ideas

There are several core ideas justifying Reciprocal Parliamentary Approval in the Eurozone. They all start from the assumption that a credible no-bailout rule has little chance of materialising in the near future. Accordingly, stronger incentives for national governments and parliaments to limit public deficits and debt in the first place will be the main pillar of fiscal stability in the Eurozone.

  • First, the proposal increases taxpayers' and the parliamentary representatives' powers for limiting excessive debt accumulation in parts of the Eurozone. This way, taxpayers can militate against lax fiscal policies in other Eurozone countries, policies they would ultimately have to foot the bill for if they did not have the power to prevent them.
  • Second, national parliaments would have considerably higher incentives to control public deficit and debt, as otherwise they might risk rejection of an above-threshold budget deficit by their fellow Eurozone countries. This would be tantamount to a temporary loss of sovereignty and a dent in national pride, which, of course, no office-holder is going to provoke lightly.
  • Third, our framework may induce countries to implement more efficient debt-brakes at the national level (see Gersbach 2010b and Becker et al 2010 for recent examples). Accordingly, it reduces the necessity of conducting external parliamentary voting in the first place.
  • Fourth, reciprocal parliamentary voting would still leave national governments with the powers required to stabilise negative macroeconomic shocks and deal with catastrophic events. Minor budget deficits would be entirely the business of national governments, while higher deficits requiring approval from other parliaments would very likely be given the green light if severely negative aggregate events indicated their necessity. 
  • Fifth, Reciprocal Parliamentary Approval might strengthen the democratic legitimacy of the Eurozone as a whole, as national parliaments would have more influence on the course it would take in future. Moreover, it would be conducive to (more) public discussion of fiscal policies and holds out the prospect of the ECB's independence being fully respected again.
  • Sixth, the requirement that external parliaments have to approve any budget deficit exceeding a certain threshold is a simpler approach than the review-and-punishment procedure envisioned in the reform of the Stability and Growth Pact. In particular, it makes procedures for determining fines unnecessary.

I should stress that it would still be useful for the European Commission to review draft budgets to ensure that thresholds requiring external parliamentary fiscal approval are not undercut by accounting manoeuvres. Many other issues would also require in-depth consideration before such a fundamental change in the democratic underpinnings of the Eurozone's fiscal policy could be implemented. But such alternative institutional architectures may be precisely what is needed to steer the Eurozone into calmer waters.

Conclusion

The time may have come to overhaul the democratic foundations of fiscal policy and indeed the foundations of the Eurozone as a whole. Reciprocal Parliamentary Approval would represent a fundamental reform of the Eurozone as an institution. It is likely to reverse public debt-making and may hold out prospects for this heterogeneous community of countries to retain the status of a monetary union that is actually useful to its citizens.

References

Becker, JG, H Gersbach, and O Grimm (2010), “Debt-sensitive Majority Rules”, CEPR Discussion Paper No. 7860.

Buti, M and M Larch (2010), “The Commission proposals for stronger EU economic governance: A comprehensive response to the lessons of the Great Recession”, VoxEU.org, 14 October.

Cooley, TF and R Marimon (2011), “A credible commitment for the Eurozone”, VoxEU.org, 20 July.

De Grauwe, P (2010), “Why a tougher Stability and Growth Pact is a bad idea”, VoxEU.org, 4 October.

Fuest, C (2011),  “Will the Reform of the Institutional Framework Restore Fiscal Stability in the Eurozone?”, CESifo Forum, 12(2):34-39.

Gersbach, H (2010a), “Vote-share bonds”, VoxEU.org, 14 November.

Gersbach, H (2010b), Government Debt-threshold Contracts, CEPR Discussion Paper No. 8001.

Issing, O (2008), “Does a Currency Need a State?”, International Finance, 11(3):297-310.

Manasse, P (2010), “Stability and Growth Pact: Counterproductive proposals”, VoxEU.org, 7 October.

Pincus, SCA and JA Robinson (2011), “What really happened during the Glorious Revolution ˗ and why it matters for current fiscal crises”, VoxEU.org, 7 August.

Suarez, J (2011), “A three-pillar solution to the Eurozone crisis”, VoxEU.org, 15 August.

Wyplosz, C (2010), “Eurozone reform: Not yet fiscal discipline, but a good start”, VoxEU.org, 4 October.


1 For a detailed discussion of the logic behind this, see Issing (2008).

2 One might also call them “Reciprocal Parliamentary Referenda”, although in matters of state, the term “referendum” usually refers to the fact that the citizens have the final say. Parliamentary approval of the budget deficit of a given country might also be performed by the representatives of other member states of the European Parliament.

3 One might envision alternative debt threshold levels for a transition period.

4 In order to check whether budget and debt plans exceed the thresholds, procedures developed for the Growth and Stability Pact could be used (see here). Moreover, if a country has no approved budget plan, emergency rules guaranteeing essential governmental functions would set in. If a country failed to achieve budget approval on various occasions, it could be excluded from the Eurozone. 

 

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Topics:  EU policies Monetary policy

Professor at CER-ETH - Center of Economic Research at ETH Zurich and CEPR Research Fellow

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