New fiscal rules for the euro

  At the end of the 1950s, the core of what is now the European Union embarked on the path towards creating a common market. From that it went on to a single market and, in the 1990s, the construction of Economic and Monetary Union took shape: closely linked economic integration emphasising the coordination of economic and, most particularly, fiscal policy. The ultimate aim was the creation of a single currency. The start-up of the euro and the founding of the European Central Bank represented the culmination of this singular process of supranational integration.

  The euro worked normally during its first decade and even largely protected its members from the turbulences of the 2008-2009 crisis. But, contrary to what some people had expected, it did not help economies converge in terms of productivity or external competitiveness, for example. It even widened some imbalances, such as the external deficit and asset bubbles.

  The basic component of monetary union, as it had been designed in Maastricht, also failed: fiscal discipline. The survival of the single currency relied on support from healthy public finances in each and every one of the countries in the euro. To this end, the Stability and Growth Pact was agreed, a fiscal rule that was to ensure excessive public deficits would be a thing of the past. The Member states of the euro kept control of their fiscal policy but with perfectly demarcated limits and accountability.

  Or perhaps not. In practice, the Pact's supposed discipline had already become diluted in 2003 and, in retrospect, the rule's effectiveness was deficient. Structural public deficits continued in many countries so that, when the global crisis hit their economies, the deficits scaled unexpected heights. The little leeway gained during the boom years quickly ran out due to the action of automatic stabilizers, the emergency aid given to the banking sector and fiscal stimuli provided to offset the fall in aggregate demand. Once financing markets closed their doors and there was no last resort provider of liquidity, the serious state of public finances in some euro area countries became critical. Bail-outs for Greece, Ireland and Portugal attempted to avoid bankruptcy and the collapse of the euro area.

  But, although extremely important, resolving the immediate problem of countries with liquidity or solvency problems is not the only dilemma. The question is what must be done to stop this from happening again. The European Union's initial response has been to remodel the mechanisms of economic and budget coordination: a reinforced Stability and Growth Pact together with stricter and more forceful corrective and preventative measures. Moreover, at December's summit, the Council decided to raise the fiscal rules to the status of a treaty, firmly entrenching the principle of budget stability. This is an important step but it is not enough. The institution or process to provide liquidity in the last resort still needs to be defined within the monetary union. The current bail-out fund and the one that will come into force this year are insufficient as they currently stand. The «communitarization» of debt or transferring this function to the European Central Bank are options that arouse controversy. Real progress towards greater fiscal integration would require a parallel advance in political integration, a challenge that must be faced by the European Union.

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