Is the EU Fiscal Compact enough to avoid another Euro Crisis?


Seminar Paper, 2012
28 Pages, Grade: B bzw. 1,7

Excerpt

Content

Summary

1. Introduction
1.1 Background
1.1.1 Membership criteria to enter the EMU
1.1.2 Fiscal Compact
1.2 Research question

2. Theory
2.1 Liberal Intergovernmentalism
2.2 Spillover effects
2.3 Economic shocks

3. Methodology

4. Analysis

5. Conclusion

6. Bibliography

Appendix

Summary

This paper investigates the evolvement of the Fiscal Compact out of the Maastricht stability criteria using liberal intergovernmentalism and economic theories and gives an outlook into a possible future.

The new Fiscal Pact includes an automatic mechanism that sets in directly when a member state reaches a high public debt or government deficit. Furthermore, the EU Court of Justice has the competence to punish countries that have breached the treaty.

This crisis has shown that the integration between the euro zone members states is increasing, especially due to the need of fiscal and economic surveillance. The liberal intergovernmentalist approach explains how the increasing cooperation between the member states results into more enforcing supranational rules but also on why the EU might still be considered as a weak institution. This paper focuses on the underlying economic problems and how the euro member states seem to be able to cope with the crisis. It shows how the Stability and Growth Pact in the Maastricht treaty has not been enough and that due to the crisis, economic and fiscal integration as well as enforceable rules are getting more important and are leading to a stronger integrated monetary union.

The coordination and convergence between the different fiscal and economic policies will be increased in future, leading to less negative spillover effects. But even though cooperation and coordination are increasing, the need for a solid anti-shock mechanism remains. There is no mechanism that can help in the case of adverse shocks that do not depend on excessive government spending.

The Fiscal Compact just introduced new budget deficit limits that might be enforceable but it will not help countries that get hit by a shock. In order to cope with asymmetric economic shocks institutional changes have to happen in order to do so. On the other hand, governments have shown that they are able to adjust to crises and accepting compromises.

1. Introduction

The euro has experienced a crisis in recent years. Since the global losses due to the financial crisis starting in 2007, the euro zone has gotten into trouble as well. Greece, Portugal and Ireland turning into deeply troubled countries that have to get rescued by the other euro zone members. But they are not the only ones; other countries like Spain have recently become public with also being in economic trouble (Die Zeit, 2012). Hugh public debt and budget deficits lead the euro area into a crisis. As a result the Fiscal Compact or Treaty on Stability, Coordination and Governance was signed on March 2, 2012. It entails features that are made to stabilize the currency and the euro zone economy. For the first time, it even inhibits a mechanism that will allow the EU Court of Justice to punish the countries that breach the treaty.

This paper investigates the evolvement of the Fiscal Compact as the interplay between the member state and not as an action done by the European Union. Furthermore, it argues how it has been come about that member states are giving up part of their sovereignty and gives an outlook into the future.

1.1 Background

1.1.1 Membership criteria to enter the EMU

The Maastricht Treaty imposes five criteria on countries that have to be fulfilled to enter the European Monetary Union. These criteria have been set in order to stabilize the currency.

These criteria are:

- Inflation rate which is supposed to “not exceed the average of the three lowest inflation rates achieved by the EU Member States by more than 1.5 percentage points” (Baldwin, Wyplosz, 2006)
- Long- term nominal interest rate “should not exceed the average rates observed in the three lowest inflation rate countries by more than 2 percentage points” (Baldwin, Wyplosz, 2006)
- ERM membership “for at least two years without having to devalue its currency” (Baldwin, Wyplosz, 2006)
- Budget deficit of no more than 3% of the GDP (Maastricht treaty, 1992)
- Public debt of no more than 60% of the GDP (Maastricht treaty, 1992)

The first three criteria refer to the level of inflation, first the inflation rate itself, then the long-term nominal interest rate as a low long-term nominal interest rate reflects the market thinking that inflation will remain low. The ERM membership specifies a time frame in which the currency is not allowed to be devalued which reflects a low inflation rate as well. The two last criteria refer to the reason for inflation which are excessive government spending. As too high spending leads to the government asking the central banks to print money and the high money growth leads to a devalued currency and inflation (Baldwin, Wyplosz, 2006).

The requirements regarding budget deficit and public debt are referred to as part of the Stability and Growth Pact, which the euro zone countries signed to stick to as long as they are in the euro zone.

Especially interesting in this paper are the requirements to have a budget deficit of no more than 3% of the GDP and public debt of no more than 60% of the GDP and the note that even in the year of introduction these requirements had not been fulfilled by the states introducing the euro.

1.1.2 Fiscal Compact

Signed on March 2, 2012, the Fiscal Compact or also called “Treaty on Stability, Coordination and Governance” intends to increase fiscal discipline and to have better monitoring surveillance of the euro member states. The three most important features are first of all that national budgets have to be in balance. This would be fulfilled as long as the structural government deficit is not over 0.5% of the GDP. (EU, 2012) The structural government deficit is the deficit that would still exist if the economy were performing at its best (FT, 2012). If in a member state it exceeds this limit, an automatic correction mechanism will be applied as well as the EU Court of Justice has the right to imply a penalty on that state. This penalty can be up to 0.1% of the GDP. Secondly, the treaty imposes fiscal rules on the euro member states. And lastly, it entails provisions to coordinate economic policies of member states, as well as governance of the euro zone and the goal to converge economic policies (EU, 2012). This treaty is particularly important for the euro zone member states and increases cooperation between them to cope with economic and fiscal disparities in the euro zone. Furthermore, it increases the opportunity of surveillance of the national states budgets.

1.2 Research question

The economic criteria in the Stability and Growth Pact have proved to be too weak. The euro member states have been breaching the Pact since it was introduced and no country was punished for doing so. The introduction of the Fiscal Compact is supposed to change this. The EU Court of Justice gets the mandate to rule over countries breaching the newly set deficit rules. For the first time, the EU would be able to enforce its rules, resulting in better convergence of national fiscal and economic policies.

So we wonder how has it come that far? Why have the euro zone member states agreed on cooperating in fiscal rules, setting a stricter budget and even provide a body who is able to execute the rules and sanction as well as monitor member states.

Therefore this paper investigates the evolvement of the Fiscal Compact out of the Maastricht stability criteria using liberal intergovernmentalism and economic theories and gives an outlook into a possible future.

2. Theory

2.1 Liberal Intergovernmentalism

In liberal intergovernmentalism, states are seen as the central actors with their own interests and who want to maximize their utility. The interests of states are issue-specific and therefore their bargaining power also changes from issue to issue. Furthermore the states are moving around in a space that does not incorporate a centralized authority that is able to enforce political decisions (Schimmelpfennig, Rittberger, 2001). Supranational organisations like the EU are more seen as a body that organizes and co-ordinates policies as well as reducing transaction costs and enabling the member states to get into negotiations and co-operations (Schimmelpfennig, Rittberger, 2001). Countries that have most gains from integration, are integrating most and doing the biggest compromises while countries that do not have such gains from integration are imposing higher conditions on their agreement to specific issues (Moravcsik, 1998). The space for negotiations is needed as EU policy-making is taking place in intergovernmental negotiations, which usually also need all member states to agree on the policy introduced. Issues, which have been moved from national level to the supranational level, are usually these who should get removed from domestic pressure and of the influence of domestic politics in order to guarantee compliance. Furthermore, it also regards to issues that would only be monitored by decentralized intergovernmental control. This would be a too weak control to ensure compliance (Moravsik, 1998). If issues score high on the importance scale, governments are prepared to not take decisions unanimously but taking decisions by other measures. These issues are the ones for which the fear of non-compliance of the other states is especially high and governments feel that they have to move these issues on a supranational level in order to get the guarantee that other states are fulfilling the requirements of the policy. Furthermore, governments might get scared that if the policy is not introduced, the ones who are against it, might revise it (Moravsik, 1998). If an issue has not high importance for a member state, it does have the best opportunity to threaten other member states by not co-operating and therefore it might be able to force them to do amendments (Schimmelpfennig, Rittberger, 2001. The fear of being affected too much by domestic politics as well as the opportunity of having a compliance control on a supranational level, leads to important issues being dealt with on a supranational level. Due to the self-interests of member states, the supranational actor has efficiency problems, a low bargaining power and it is only established to sanction and monitor each other (Schimmelpfennig, Rittberger, 2001). This shows the high importance of national states, even though a supranational body has been established and the limited power this supranational body has.

[...]

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Details

Title
Is the EU Fiscal Compact enough to avoid another Euro Crisis?
College
BI Norwegian Business School
Course
The EU Policy Process
Grade
B bzw. 1,7
Author
Year
2012
Pages
28
Catalog Number
V193727
ISBN (eBook)
9783656196013
ISBN (Book)
9783656196099
File size
921 KB
Language
English
Tags
EU, Euro Crisis, Fiscal Compact, Euro, Intergovernmentalism, Fiscal Union, Fiskalpakt, Europäische, Union, European, Eurokrise
Quote paper
Katharina Osterholt (Author), 2012, Is the EU Fiscal Compact enough to avoid another Euro Crisis?, Munich, GRIN Verlag, https://www.grin.com/document/193727

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