Tuesday, May 8, 2012
How to Rebalance the European Fiscal Compact
Here is the problem: on the one hand, it is urgent to get countercyclical funds flowing in the Eurozone, particularly in regions hit by double-digit unemployment. Dealing with trade imbalances and placing the banking sector on more secure footing are longer term objectives; growth needs to be restarted within months or the European project at a whole is in serious danger of collapse. On the other hand, however, there is neither the institutional framework nor political support from Germany (a sine qua non) for either a relaxation of fiscal targets or central underwriting of sovereign debt.
Nevertheless, there is a way out.
(1) Keep the current fiscal targets. Perhaps provide some form of central underwriting for a portion of old debt, to cap interest costs, but not for new debt.
(2) Create a European-level investment authority, linked to the European Investment Fund (or the Bank) with a mandate to conduct countercyclical public investment, financed by loans, most of which would be purchased by the ECB. This authority would spend directly, not lend, and it should target its spending in regions in greatest need of fiscal stimulus. Decisions regarding the overall size of its program and its distribution across countries would be taken on a supermajority basis of national representatives. Thus the political conundrum of national sovereignty over fiscal policy and the necessity for interregional transfers would be overcome at the level of the Eurozone as a whole: it would be the Eurozone as an entity that takes on burden of countercyclical deficits and turns to the ECB for accommodation.
Note that this loosely parallels the institutional framework used in the currency zone called the United States. Individual states do not have the ability to run operating deficits, nor do they normally look to the Fed for finance; this function is federal only.
In this way the emerging European growth consensus can move quickly to expand public spending in the most affected regions, while avoiding the perceived moral hazard of backstopping the deficit policies of some countries with the savings of others.