Macro-Economic Policy in the Euro Zone

8/12/2019 Macro-Economic Policy in the Euro Zone

1/5

Richard Prins, 2510403. Course Instructors: Dr. Hulst & Dr. Crum. 23/3/2014.

Macro-economic policy in the Euro zone.

In 2009, fear of a sovereign debt crisis grew, partly because of high government

expenditures to counter the banking crisis in 2008, such as the European fiscal stimulus

package. In 2010, Greece especially experienced a rising price for government

borrowing leading to an inability to finance its budget. This formed the risk of contagion

to other southern European states, and the break-up of the Euro zone itself. The

governments initially responded (although late) through the intergovernmental

providing of a loan to Greece. Euro zone leaders also agreed on initial programs (EFSF

and EFSM) to provide financial support to governments in need. In 2011, the sovereign-

debt crisis intensified, as the financial aid programs would not be able to support larger

states. In 2011 and 2012 the six pack and the Fiscal Compact were agreed on,

introducing stronger surveillance on the budgetary discipline of Euro states. Also in

2011, the ESM was signed as a successor to the previous programmes, also using an

intergovernmental decision structure (Hudson & Puetter, 2013).

While van Rompuy has declared that the existential threat to the Euro is over,

others are not so relieved (Glienicker group, 2013). This paper will look at the future of

the Euro. An option has always been the break-up of the Euro zone, but this paper will

focus on policies in which the Euro is retained. These policies can be divided in two

categories. The first one is to continue the course set by the intergovernmental treaties

signed in 2010-2012, under the leadership of firstly Germany and secondly France,

called muddling through (Overbeek, 2012). The second option is to transfer a

considerable amount of decision-making authority with respect to national macro-

economic policies to EU institutions, Europeanization (Overbeek, 2012).

Muddling through is politically the easiest option, and the natural tendency of the

EU (Overbeek, 2012). Furthermore, this option is in the best interest of Germany,

economically the strongest Euro state and therefore the state with the strongest

negotiating position. It has opposed the buying up of bonds by the ECB, and it has

opposed the creation of Eurobonds. Both would make Germany more vulnerable in the

case of the default of a Euro state (Overbeek, 2012), while the Eurobonds would also

raise the cost of borrowing money for Germany (Pisani-Ferry, 2013). And while


2/5

Northern European countries have been able to adapt to the post-crisis economy and

are experiencing minimal economic growth again, the Southern European economies

are facing economic decline (Darvas, 2012). Furthermore, Eurobonds would provide a

disincentive to budgetary discipline in economically weaker states. When there is aEurobond however, states can keep on borrowing at the same rate, even when they are

putting themselves in a more risky position. However, there is a suggested solution for

this problem, stricter budgetary oversight (Pisani-Ferry, 2013). According to Bordo,

Jonung, and Markiewicz, (2013) other examples of fiscal unions indicate that having a

no-bailout rule is the best for stable budgets, a no-bailout rule meaning that the highest

governance level should not assume the debts of the member states.

According to Pisany-Ferry (2013), the current Euro zone policy amounts to the

enforcing of fiscal discipline, which, they assert, is not enough to restore stability.

Countries with less than a 60% of GDP debt have in the past still suffered default

(Pisany-Ferry 2013; Bogdandy et al. 2013).

The current approach of intergovernmentalism reacted rather slow. This has

driven Germany and France to take the lead. This style of government carries with it a

legitimacy dilemma. Because of the intergovernmental character, the European

Parliament is not involved to provide democratic oversight (Fabbrini, 2013). National

parliaments are incapable however of effectively controlling collective European

intergovernmental decision-making (Fabbrini, 2013; Overbeek, 2012).

Because of the disadvantages associated with muddling through, many authors

do not find this a feasible option (Overbeek, 2012; Pisani-Ferry, 2013; Glienicker group,

2013; Darvas, 2012). According to the Glienicker group, the problems underlying the

crisis have not been solved, debt problems continue to grow, and Southern Europe

remains in a deep economic recession (Glienicker group; see also, Darvas, 2012). Their

suggested solution is a deeper Europeanization.

Europeanization would mean i.a. the forming of a minimal fiscal union (a tighter

common fiscal framework and a mutual guarantee of part of the public debt (Pisani-

Ferry, 2013, p. 12) with Eurobonds. Member states would have a common way of

financing their debt and would guarantee each others debts. In exchange, states would

have to submit their budgets for approval, and would be liable for sanctions if their


3/5

borrowing behavior would transgress certain rules. Eurobonds would create a safe

asset for banks to invest in, and provide all states with a reliable borrowing option. As

mentioned above, this will mean higher borrowing costs for Germany and other

economically strong states, but lower costs for weaker states (Pisani-Ferry, 2013). Anobstacle to these options is the mistrust between states, and the complexity of the

structures required in the absence of deeper political and fiscal integration (Darvas,

2012), especially in the light of France's unwillingness to form a more federalist system

(Pisani-Ferry, 2013).

Another suggested policy is the creation of a banking union, moving the

responsibility for supervising and for saving banks to the European level. Currently

there is a bank-government interdependence problem. Banks often hold large amount

of government bonds, making them dependent on governmental budgetary stability,

whereas governments have had to put themselves into deep debts to save their banks

(Darvas, 2012; Pisani-Ferry, 2013). According to proposals banks would be regulated

more, to incentivize them not to rely that much on the bonds of one state. This might be

effective but it might also lead to difficulties for weaker Euro states to finance their

debts. Furthermore, debt restructuring will retain its large impact on banks because of

the scale of member state governmental debts as compared to e.g. US state debts.

Changing the bank system may also have its impact on a wide range of topics like

pension funds assets (Pisani-Ferry, 2013).

Some way of restoring the economies of Southern European countries is also

suggested to be part of a plan of Europeanization. Overbeek (2012) and Darvas (2012)

suggest some form of transfers, where a larger budget is given to the EU so that it can

support lagging regions, in effect transferring money from richer to poorer member

states. The small amount of investment is not enough however, to boost growth, and

the Southern economies also have bigger structural problems that need solving (Darvas,

2012).

Overall, it seems that European institution need larger decision making authority

in the light of the slowness and inability to address deeper problems of the current

reaction. Furthermore, Europe needs to have more macro-economic tools at its disposal

such as a more concerted fiscal policy, and common pooling tools such as Eurobonds.


4/5

The stalling economies of the South need to be helped by other forms of solidarity such

as transfers, and the Southern economies need to boost competitiveness. However,

large political obstacles remain as Northern states will have to foot the bill of these

plans, and because resistance to a more federal Europe remains strong, especially inFrance. The future of the Euro necessitates action however, as muddling on seems not

to be an option.

Literature

Bordo, M. D., Jonung, L., & Markiewicz, A. (2013). A fiscal union for the euro: Some

lessons from history. CESifo Economic Studies, 59(3), 449-488.

Darvas, Z. (2012). The euro crisis: ten roots, but fewer solutions. Bruegel

Policy Contribution, (No. 2012/17).

Fabbrini, S. (2013). Intergovermentalism and its Outcomes: the Implications of the

Euro Crisis on the European Union.LUISS School of Government Working Papers

Series (SOG-WP1/2013).

Glienicker group (2013). Towards a euro union. Retrieved from:

http://www.bruegel.org/nc/blog/detail/article/1173-towards-a-euro-union/

Hudson, D. & Puetter, U. (2013). The EU and the Economic Crisis. In Cini, M., &

Borragn, N. P. S. (Eds.). European Union Politics (pp. 367-378). Oxford: Oxford

University Press.


5/5

Overbeek, H. (2012). Sovereign debt crisis in Euroland: Root causes and implications

for European integration. The International Spectator, 47(1), 30-48.

Pisani-Ferry, J. (2012). The euro crisis and the new impossible trinity.Bruegel Policy

Contribution, (No. 2012/01).

Documents

Macro-Economic Policy in the Euro Zone