The European Commission announced in October that it is creating a new agency tasked with helping member governments draft and manage their budgetary policies. At the same time, it asked a study group to examine the possibility of introducing a European guarantee on bank deposits in the eurozone.
These two steps are correlated, and should be interpreted as part of the European Union’s broader effort to overcome an internal conflict between advocates of budgetary rigour and profligacy. The deposit guarantee may be an attempt to win back public opinion that has become estranged from European ideals, and at times openly hostile to them. What scenarios open up during the next months will depend heavily on the attitude of the European Central Bank, and also on the extent to which EU leaders resolve the uneasy balance of power between national politics and a centralising technocracy.
Last month, the European Commission felt obliged to show that it is in control of the fragile economic situation and made two announcements. First, the Commission declared it is on track to create a European Fiscal Board – an advisory body charged with monitoring national governments and giving them appropriate guidance in shaping and managing their public budgets.
The Commission also said it would soon present a proposal to replace the current national guarantees of bank deposits in the eurozone with a European guarantee. This would suggest that the ideological battle cry in Brussels continues to be integration and consolidation, rather than decentralisation and national fiscal responsibility.
Although these proposals look somewhat vague and are not entirely new, they provide insight into the likely direction of future developments. The broad outlook is defined by three sets of issues that have shaped the activities of the European Commission and of the ECB during the latest economic crisis, some of which Brussels is now trying to address.
The first is a straightforward dispute over the direction of fiscal policy between politicians in the member states, who for simplicity’s sake can be labelled as the hawks (adherents of budget discipline) and the spendthrifts (proponents of disobeying the EU budget rules). A second set of issues revolves around the EU’s efforts to win back legitimacy and popular support for the European ideal, whatever this might be. The third concerns a power struggle that has heightened tensions between the political elites of the member states and the high-ranking officials and technocrats of the EU apparatus in Brussels.
The European Commission’s proposal to move forward with the fiscal board addresses the first issue (the future direction of EU policy), while the deposit-guarantee proposal advances the second (restoring public confidence). However, unless the third issue – the struggle for power – is resolved, European policy making will continue to lose credibility and may actually contribute to worsening economic conditions on the continent. Let us examine each of these points in turn.
Spendthrift countries within the eurozone are still having trouble with their public finances. This applies to relatively fast-growing countries like Spain, where economic expansion in 2015 should reach 3.3 per cent, as it does to disappointing performers such as Italy and France, where growth should barely crack 1 per cent. Until now, the situation has been relatively manageable thanks to artificially low interest rates (Italy, for example, was recently able to issue short-term treasury bills bearing a negative yield).
But sooner or later, the ECB will have to cut back on its bond-buying and quantitative easing will come to an end. Brussels understands that it had better get ready. Currently, the most credible alternative to quantitative easing is the issuance of sovereign European bonds. These could replace – at least partially – current bonds issued by the national governments and could ultimately be guaranteed by giving the EU autonomous powers of taxation.
It could be argued that the EU has no need for an independent agency to monitor and evaluate fiscal discipline, since this job is already being done by the European Commission. However, matters would be different if the EU ultimately succeeds in obtaining discretionary taxing power. Within that context, the fiscal board could be expanded to manage and run a European tax policy.
In the short run, that would require the fiscal board to evolve from a purely advisory body into one with at least a limited enforcement capacity. This would effectively bring about a separation of powers, in which the European Commission periodically defines the rules of the game regarding public finance for EU members, while the fiscal board automatically applies sanctions to undisciplined countries.
Since the new fiscal agency would be run by technocrats, ‘hawkish’ politicians in the national governments would no longer face pressure from their ‘spendthrift’ peers to soften previously agreed rules. The insertion of a new bureaucratic layer in fiscal supervision would reduce the possibility for policy adjustments along the way and effectively neutralise the spendthrifts.
Is this a plausible scenario? Much depends on what happens in the near future. As recent history shows, it is not at all obvious that the spendthrifts will consent to give up their fiscal sovereignty and the chance to convert financial negligence into a political bargaining chip. Following this line of reasoning, either the hawks give up on their plans for augmenting fiscal discipline or they look for support to the ultimate enforcer – the ECB.
The instant investors begin to have doubts about quantitative easing and the future generosity of the monetary authorities in Frankfurt, bad things will start to happen in the fragile eurozone economies. Yields on public debt will start to rise, many commercial banks would find themselves on the verge of bankruptcy, and ‘spendthrift’ national politicians may perhaps be more amenable to replacing the current ECB lifeline with a new arrangement. The latter might include public-debt guarantees from the European Commission in exchange for augmented enforcement powers for the fiscal board.
The ECB could also help with providing another incentive – a European guarantee on small and medium-sized bank deposits. This might not make much sense from an economic standpoint, since the provision would continue to encourage irresponsible behaviour by depositors and imprudent lending by bankers. Yet a deposit guarantee is badly needed from the political perspective. No single European government or national banking system has the resources to refund depositors should a major bank go to the wall.
Furthermore, the measure would help to revive the image of European institutions among the general public. While not many people see the rationale for a federalist European state (hence the EU’s so-called legitimacy gap), that sentiment would quickly change if people felt their savings were at risk and that the only way to protect their financial well-being was through a pan-European institution. Deposit insurance is not at all a panacea, but it could be perceived as a step in the right direction and a bulwark against a potential systemic collapse.
While the scenario outlined above follows logically from the European Commission’s recent announcements, it remains highly speculative. Many interconnected events must take place and different actors must cooperate. Fiscal hawks in the EU countries will need help from the ECB to tame the spendthrifts, and ECB President Mario Draghi may have his own ideas about the future of monetary policy. Moreover, the hawks must be willing to transfer much of their political power to the EU technocracy – a delicate issue in regard to which many options are still open.
This last consideration may well be the deal-breaker. Bridging differences over fiscal policy will be impossible without mending the profound fracture between the democratic and technocratic souls of the European Union – the power struggle mentioned earlier in this report. Unless that conflict is resolved, we will witness further disarray and confusion about operational and strategic objectives in Brussels, Strasbourg and even Frankfurt.
A mixture of centralising ideology and self-complacency has led the EU political elites to engage in ever-increasing regulation, which has transferred power to high-ranking bureaucrats and generated enormous resentment among politicians and voters in the member states. This tension will weigh more heavily on the EU’s future than any fiscal board or new bailout programme for careless depositors.
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