The euro: tough sanctions not the answer

 October 24, 2010

The recent Merkel-Sarkozy compromise regarding penalties against EU states which ring up big budget deficits has been attacked by German coalition partners, experts and the press for being too mild on offenders. In an article published on Europe’s World (“Designing a new institutional architecture for the eurozone”), Mr. Jurgen Stark, executive board member of the ECB, had endorsed strong punitive measures against those who break the Growth and Stability Pact convergence criteria. He is not the only expert to endorse strong automatic sanctions for offending states. But how wise, for example, would it be politically to suspend the voting rights of states for finding themselves in financial difficulty ?

Before the euro’s introduction, its supporters had to contend with strong opposition to European monetary union not only from the US, the UK and Japan, but also from Germany. Germans were loath to renounce their beloved deutschemark and German economists even challenged the right of Germany to adopt the EMU in court.

Now that the euro has proven its usefulness and value, a small group of countries within the EU, which includes Germany, Finland and the Netherlands, wants to use strongarm tactics against weaker monetary union partners in order to rein in their budget deficits and reduce their public debt load. Alas, not all 16 members of the monetary union have trade surpluses, most even have to run current account deficits in order to import German goods. Requiring financial rectitude and dispensing punishments to those who do not comply , highlight German insensitivity to the problems experienced by the economies of EU countries other than their own.

This is not to say that EU members should not behave in a financially responsible manner, be transparent in their finances and accountable in their actions. I am simply saying that clobbering them for experiencing financial difficulties will not entice others to join the euro-club. Making the rules too rigid or adopting unreasonable sanctions could see the euro remain the currency of a small group of countries, regardless of how beneficial a common currency is.

The 3 % budget deficit target was agreed upon at Maastricht when the European economies were booming. Its main proponents were representatives of countries whose stringent fiscal management is the exception within the EU, and not the rule. From the start, however, the 3 % target was an over-optimistic benchmark that did not factor in any potential for economic turmoil down the road. Before the launch of the monetary union, I had sensed that the 3 % deficit target was going to be a major problem once the boomtime would be over, and I wrote so at a conference on the EMU in 1997, advocating for a flexible budget deficit target. This is because some EU countries could indeed achieve balanced budgets, while others – because their economy is weaker – chronically run a budget deficit. Here, a compromise, not a German-type diktat is needed in establishing a deficit target of, say, some 5 % of GDP, making the European Union accommodating to all, not only to a few.

To complement that, an IMF-type institutional arrangement should be arrived at within the EU, which would combine incentives and financial assistance with stringent reporting rules and measures aimed at mandating member-states to behave in a fiscally responsible manner. The sanctions in case of non-compliance, to be sure, could not include half-evicting member states, by suspending their voting rights. Going down that road, the Union would run the risk of remaining with only one member – Germany…

Realistic deficit and public debt targets, as well as a carrot-and-stick approach to enforcing fiscal discipline across the Union are what we actually need. What we do not need are tight-fisted central bankers and closet disciplinarians who take their own countries’ exceptional budgetary situation as a yardstick for us all.