Macroeconomic Policy in the European Monetary Union

Francesco Farina, Roberto Tamborini, Francesco Farina, Roberto Tamborini

• Publisher: Routledge
• Year: 2007
• ISBN:
  9781134109371
• Edition: 1
• Topic: Business
• Subtopic: Business generale
• Index: Business

Providing readers with a multi-faceted assessment of the implementation of fiscal policies in the euro zone and their macroeconomic effects five years after the inception of the euro, this book, international in perspective and scope, is the first reliable reference source for discussions in this area for both academics and policy makers.Comprising

1 Introduction

F. Farina and R. Tamborini

On 1 January 2007, the euro celebrated its fifth anniversary of circulation as the single currency of twelve countries of the European Union (EU). On the same day, the euro club welcomed the thirteenth country, Slovenia. The protracted and sometimes confused debate on the costs and benefits of a single currency, on Europe as an optimum currency area, and on the accession parameters has become a matter for the historians. The task now is to understand the extent to which the common monetary house is robust, well-designed and in line with the aspirations of the citizens who inhabit it.

This book collects contributions of distinguished researchers from different European countries and institutions who met at the conference series organized by the Jean Monnet Chair in ‘European Macroeconomics’ at the University of Siena (Italy) in 2004–6. The contributions selected for this book focus on economic policy in the context of macroeconomic stabilization goals in the European Monetary Union (EMU). Taking stock of the long-lasting debate about the pros and cons of the design of the EMU, the general aim of the book is to provide the reader with a multifaceted assessment of the implementation of macroeconomic policies in the euro zone and of their effects five years after the inception of the euro.

The state of affairs

On the fifth anniversary, the press has given prominence to opinion polls about the citizens’sentiments towards the euro. An example, drawn from the Eurobarometer survey, is provided by Table 1.1, reporting on the perceived cost-benefit balance after adoption of the euro.

The picture is not particularly rosy, both in absolute terms (only 48% of the EMU citizens strike a positive cost-benefit balance) and in terms of trend over time (the percentage was 51 one year earlier). The most significant item on the cost side of the balance is the rise in the general price level (81% of respondents); at some distance followed by difficulties in adaptation and use (19%), higher unemployment (7%) and loss of sovereignty (5%).

The opinion of academics is well represented by Charles Wyplosz (2006), who sees some ‘dark sides’ in a ‘major success’. Interestingly, the academic ranking of discontent is almost the reverse of that of the general public: low and stable inflation is ranked high on the positive side of the balance sheet; problems of acquaintance with the new currency are not even mentioned. The poor performance of the euro area in terms of growth and job creation is not charged to the single currency. On the other hand, prominent on the negative side of the balance sheet are some flaws in the institutional design of the area. These concern the transparency and accountability of the European Central Bank (ECB), and the trembling Stability and Growth Pact (SGP). As a matter of fact, the only major setback in the general functioning of the euro area in these five years has occurred at this junction, namely the suspension of the SGP excess deficit procedure obtained by Germany and France in November 2004 in opposition to the Commission’s recommendation.

Table 1.1 Percentage of respondents for whom the benefits of the euro are greater than the costs

This event reminds us that, eventually, the most important opinions remain those of the political forces that alternate in power in the EMU sovereign states. These opinions, however, are not easily intelligible, and may be revealed more by deeds than words. In this respect we can only say that the SGP crisis is a representation of a more general tension in the EU among the three key actors on the stage of democracy: elected governments, public opinion and technocrats (Fitoussi, 2002). This tension has been tangible throughout the entire history of the EMU, from the Delors Report and the Maastricht Treaty, to the adoption of the SGP and the choice of the first group of euro countries (Wyplosz, 2006; Tamborini and Targetti, 2005). This complex triangle cannot be reduced to the caricature of ‘good guys’ (economists and technocrats) vs. ‘bad guys’ (governments) as is often perceived from economic analyses and prescriptions. Whatever the economists’ opinion may be, the dissatisfaction of the majority of the public opinion with the euro, and with the EU more generally (as witnessed by the rejections of the ‘constitutional’ draft in different countries) can hardly be overemphasized when assessing finer institutional and operational aspects of the EMU. And if economists may, with some reason, wish to refrain from being involved in these matters, they should be aware that ‘politics’ amounts to much more than a white noise in models and forecasts.

Hence, introductorily we wish to remind the broader scenario where this epoch-making political creature should be framed, though what the reader will find in this book is a collection of self-contained, mostly empirical, economic analyses of the first five years of EMU and its prospects.

First and foremost, the EMU represents a major change in the ‘political-economic regime’ for its member countries.^{1 i} By ‘political-economic regime’we mean the set of constraints, goals and opportunities that face private and public agents in a given economic system. The liberalization of the circulation of goods, capitals and individuals, the adoption of a single currency and the devolution of monetary sovereignty to an independent supranational institution, the introduction of a common ‘economic constitution’ in the form of the Treaty of Maastricht, and self-imposed fiscal rules through the SGP, all have yielded profound consequences not only on economic magnitudes and structures but also on the economic institutions.

Following these changes, the EMU countries are shifting from a well-defined and consolidated political-economic regime – what we may call the international regime – to one still incipient, uncertain in shape, and with difficult to predict outcomes. The ancien régime was founded on the following premises: 1) The sovereignty of the policy makers – the monetary authorities (MAs) and the fiscal authorities (FAs) – had the same geographical extension as the state. 2) Geo-politics coincided with geo-economics, or, in other words, the geographical boundaries of the states and their organisms coincided with economic areas which were internally homogeneous, and mutually heterogeneous, as regards a) national identity and definition of national interests, and b) economic-social structures.

The time-honoured international regime in Europe was eroded over the last twenty years by numerous factors determining the collapse of both its premises. First, the experience of the European Monetary System of fixed exchange rates – and more in general the effects of the globalization of markets – has shown that substantial political-economic sovereignty, both in terms of independence and of effectiveness, has been lost, despite the formal sovereignty of the state (Padoa Schioppa, 1992). Second, the geo-economic map of Europe no longer exactly coincides with its geo-political map. Economically homogeneous areas (the ‘macro-regions’, in EU vocabulary) have boundaries which often cross two or more states, and this tends to disrupt the coincidence between nationality and economic interests, and the consistency of government actions defined solely by the geographical domain of the state.

In the presence of these phenomena, public economics suggests that policymaking should be articulated into ‘levels of government’ hierarchically arranged according to their ability to regulate and control the interdependences and spatial externalities of public and private economic choices. This suggestion has been followed in the past by those numerous nation-states that have devolved powers to their regions, as well as obviously by the federal states. At least from a normative point of view, the process ongoing in Europe is towards rearranging the national policy authorities into what we may call an interregional regime: that is, a system characterized by 1) a common currency, 2) the close integration of cross-border geo-economic areas which are internally homogeneous (but not necessarily homogeneous among each other), 3) the hierarchical organization of territorial economic policy competences, and therefore of policy agencies. The first manifest step in this direction has been taken with the single currency and the creation of the ECB. To a large extent, in the EMU the national MAs and the ECB are already operating in an interregional regime which may not yet be thoroughly defined as regards the allocation of functions between centre and periphery, but is nevertheless solidly established.

The framework in which the national FAs operate is much more uncertain. As yet, this framework is not even remotely interregional in nature; nor does it look like becoming so in the near future. In its present form it is a hybrid between the old and the new, one that might be called a constrained international regime. This institutional mismatch between MAs and FAs has caused much concern for scholars and politicians. It has led to the proposal of a complete interregional regime (to use our terminology) with the creation of a central FA to parallel the ECB. This view is by no means universally shared, however. Some argue that a ‘monetary giant’ surrounded by ‘fiscal dwarves’ is a better guarantee of the independence of the central bank, of monetary and financial stability, of restricted growth of the public sector, and of fiscal discipline. Yet, it cannot be overlooked that, so far, it is governments themselves that have resisted to a larger devolution of fiscal prerogatives to a supranational authority (Buti and Franco, 2005; Wyplosz, 2006). Hence, it comes as no surprise that the SGP, and fiscal policy more generally, appear as the weakest pillar of the EMU. It also seems reasonable to predict that improvements cannot only come from better economic engineering, and that they may take a long and troubled road to come.

Thus, albeit this volume has a larger scope – how economic policy works inside a monetary union – it is very much focused on the functioning of fiscal policy under the SGP. Particular emphasis is given to the constraints of the SGP on the one hand, and the presence of a single monetary policy on the other. In this respect, the focus is on the most recent advances in the literature, namely how the fiscal-monetary policy mix is actually working within the peculiar institutional setup of the EMU. The critical elements that emerge from the analyses presented here concern the evolution and control of fiscal aggregates over the business cycle and their implications for the SGP rules, the accountability of debt evolution, the financial spillovers of national fiscal policies, the measurement and assessment of automatic stabilizers, the relationship between fiscal performance and country size.

The overall assessment is mixed. In particular, the SGP is considered both as an opportunity to strengthen macroeconomic stability across the countries belonging to the euro area, and as an ill-designed institutional device to combine fiscal discipline with effective stabilization at the national level. Though the positive design of the EMU institutions and policy instruments is beyond the scope of the book, we are confident that the results presented here may allow for an informed judgement on the SGP reform introduced in March 2005 and on the prospective evolution of economic policy in the EMU. A more detailed presentation of the contributions to the volume follows in the next section.

Looking forward

We wish now to draw the reader’s attention to three main prospective issues that we distil from this assessment of the first five years of EMU.

The first is that the new SGP remains silent about the problem of monetary and fiscal policy co-ordination, thus showing a difficulty to recognize the central role of monetary and fiscal interactions in the euro area (see also Wyplosz, 2006).

The ‘consensus view’ is that monetary and fiscal policy co-ordination can be waived as the ECB and national FAs are committed to the same inflation and output objectives (Dixit and Lambertini, 2003). There results the ‘division of labour’ between the ECB taking care of EMU-wide shocks and national FAs taking care of domestic asymmetric shocks. Yet the problem of the complex monetary and fiscal interactions which develop in a monetary union should not be downplayed. The recognition of this problem will probably have to go beyond the role of the SGP rules as a substitute for open co-ordination (Beetsma et al., 2001). The role, if any, is in fact limited to the well known ‘common pool problem’. Each government in a monetary union might free-ride on the common pool of financial resources and fail to endogenize the negative spillovers (higher interest rates) towards the other members stemming from its fiscal stance. Yet, the quest for a co-ordination of national fiscal policies in the EMU does not arise only from this problem. The real question is not just a possible co-ordination failure among the FAs, but, more importantly, the overall co-ordination between a single monetary stance and a plurality of fiscal stances.

First of all, the EMU countries differ both as for growth differentials and for persistent differences across business cycles. Symmetric shocks, or asymmetric shocks originating in one country and generating spillover effects throughout the euro area, may cause different weights put by the ECB and by the FAs in their respective loss functions become relevant (Tamborini, 2004: 154–5). One or more governments might then indulge in discretionary fiscal policies which are mutually compatible with the common inflation and output objectives, but possibly not compatible with overall macroeconomic conditions as shaped by the ECB and the other FAs. The ECB and the national FAs should therefore co-ordinate in order to avoid that the impulse on the euro interest rate resulting from the governments’ fiscal stances clashes with the conduct of monetary policy.

There are reasons to think that the debate on policy co-ordination should be resumed soon. The substantial demise of co-ordinated macroeconomic policies of stabilization might not be unrelated to the large current account imbalances recently observed among EMU economies, following widening divergences across real effective exchange rates (Tamborini, 2001; De Grauwe, 2006), as well as to the structural current account surplus of the euro area as a whole vis-à-vis the rest of the world. The limitation of (unco-ordinated) fiscal policies to domestic fiscal shocks can also be questioned from a welfare point of view. As shown b...