posted by Bina | Monday, July 16, 2007
French President Nicolas Sarkozy made an unprecedented appearance at the informal meeting of the "Eurogroup"--the economics and finance ministers of the euro-area countries--on July 9.
Sarkozy made the visit to announce that Paris might fall short of its objective of achieving a balanced budget by 2010, should gross domestic product growth fall below forecast. By doing so, he also forced the July 10 meeting of the U.N.'s Economic and Finance Committee to deliberate the merits of strict adherence to the Stability and Growth Pact (SGP)--a general commitment among European Union member states to achieve a budgetary position that is close to balance or in surplus over the medium term.
Sarkozy's visit was unprecedented but not unexpected. As a presidential candidate, he made it clear he would use fiscal policy to stimulate growth, and, once elected, he said he would communicate this to the Eurogroup. His self-invitation to the informal gathering prompted widespread speculation that the credibility of European fiscal coordination is again in doubt. This built on existing concerns caused by Sarkozy's criticism of the European Central Bank for ignoring the euro-dollar exchange rate and his insistence that market competition be omitted as an explicit objective of European integration in the negotiating mandate for a new E.U. Reform Treaty.
Media accounts also pointed to the debate between the European Commission and Italian Finance Minister Tomaso Padoa-Schioppa about the pace of fiscal consolidation in Italy.
However, such discussions about the credibility of European policy coordination (including fiscal policy) tend not to specify what is supposed to be credible, and for whom. The presumption is that the goal of European fiscal policy coordination is to ensure prudent management of government accounts. Should coordination fail, some accounts will be more prudently managed than others.
In such circumstances, financial markets, specifically those in long-term government debt, ought to react by demanding a greater risk premium on some long bond yields. Long-term government bond yields should converge where coordination is credible, and diverge where it is not.
However, the dispersion of euro-area government bond yields (excluding new entrant Slovenia) does not seem to bear this thesis out. While financial markets may simply be failing to exert sufficient discipline, another interpretation is that markets do not doubt the credibility of euro-area fiscal policy and expect that larger states will sometimes break the rules.
Moreover, it is not clear whether France ought to be singled out, as a comparison with the U.K. makes clear. While the U.K. is not an E.U. member, it is involved in fiscal policy coordination and is a signatory to the SGP. Moreover, of the two countries only London is under supervision for its failure to comply with the European requirement to "avoid excessive deficits," though this supervision is nonbinding, since the U.K. negotiated an opt-out when the procedure was negotiated.
By contrast, France emerged from the excessive deficits procedure last January, and, even if it delays its further consolidation of fiscal accounts, as has Sarkozy warned, there is no doubt about its continued avoidance of "excessive deficits." Paris' breach of the letter of the agreement is thus less serious than is supposed.
On the other hand, there is evidence that small countries, or countries eager to join the E.U., will put their commitment to prudent fiscal policy coordination first. An obvious example is the furious Dutch response to France and Germany's abrogation of 2003, shortly before the Netherlands came under supervision for its own excessive deficits the following spring. Similar behavior is also evident in recent efforts by Malta to qualify for membership in the euro area and by Hungary to fulfill its obligations (albeit very belatedly) under the excessive deficits procedure.
Sarkozy's warning on fiscal policy only reinforces widespread acceptance that large member states will pay more attention to domestic growth than to European rules. Yet that does not mean that smaller member states or candidates for the single currency will insist on doing the same, or that any government should miss the opportunity of strong growth to undertake prudent fiscal consolidation. The E.U. has moved away from unrealistic interpretations of the SGP. As a result, European commitment to fiscal policy coordination is more (and not less) credible.
Sarkozy made the visit to announce that Paris might fall short of its objective of achieving a balanced budget by 2010, should gross domestic product growth fall below forecast. By doing so, he also forced the July 10 meeting of the U.N.'s Economic and Finance Committee to deliberate the merits of strict adherence to the Stability and Growth Pact (SGP)--a general commitment among European Union member states to achieve a budgetary position that is close to balance or in surplus over the medium term.
Sarkozy's visit was unprecedented but not unexpected. As a presidential candidate, he made it clear he would use fiscal policy to stimulate growth, and, once elected, he said he would communicate this to the Eurogroup. His self-invitation to the informal gathering prompted widespread speculation that the credibility of European fiscal coordination is again in doubt. This built on existing concerns caused by Sarkozy's criticism of the European Central Bank for ignoring the euro-dollar exchange rate and his insistence that market competition be omitted as an explicit objective of European integration in the negotiating mandate for a new E.U. Reform Treaty.
Media accounts also pointed to the debate between the European Commission and Italian Finance Minister Tomaso Padoa-Schioppa about the pace of fiscal consolidation in Italy.
However, such discussions about the credibility of European policy coordination (including fiscal policy) tend not to specify what is supposed to be credible, and for whom. The presumption is that the goal of European fiscal policy coordination is to ensure prudent management of government accounts. Should coordination fail, some accounts will be more prudently managed than others.
In such circumstances, financial markets, specifically those in long-term government debt, ought to react by demanding a greater risk premium on some long bond yields. Long-term government bond yields should converge where coordination is credible, and diverge where it is not.
However, the dispersion of euro-area government bond yields (excluding new entrant Slovenia) does not seem to bear this thesis out. While financial markets may simply be failing to exert sufficient discipline, another interpretation is that markets do not doubt the credibility of euro-area fiscal policy and expect that larger states will sometimes break the rules.
Moreover, it is not clear whether France ought to be singled out, as a comparison with the U.K. makes clear. While the U.K. is not an E.U. member, it is involved in fiscal policy coordination and is a signatory to the SGP. Moreover, of the two countries only London is under supervision for its failure to comply with the European requirement to "avoid excessive deficits," though this supervision is nonbinding, since the U.K. negotiated an opt-out when the procedure was negotiated.
By contrast, France emerged from the excessive deficits procedure last January, and, even if it delays its further consolidation of fiscal accounts, as has Sarkozy warned, there is no doubt about its continued avoidance of "excessive deficits." Paris' breach of the letter of the agreement is thus less serious than is supposed.
On the other hand, there is evidence that small countries, or countries eager to join the E.U., will put their commitment to prudent fiscal policy coordination first. An obvious example is the furious Dutch response to France and Germany's abrogation of 2003, shortly before the Netherlands came under supervision for its own excessive deficits the following spring. Similar behavior is also evident in recent efforts by Malta to qualify for membership in the euro area and by Hungary to fulfill its obligations (albeit very belatedly) under the excessive deficits procedure.
Sarkozy's warning on fiscal policy only reinforces widespread acceptance that large member states will pay more attention to domestic growth than to European rules. Yet that does not mean that smaller member states or candidates for the single currency will insist on doing the same, or that any government should miss the opportunity of strong growth to undertake prudent fiscal consolidation. The E.U. has moved away from unrealistic interpretations of the SGP. As a result, European commitment to fiscal policy coordination is more (and not less) credible.
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