Eurozone Watch

Today, the European Commission presented further ideas for the reform of economic governance in the EU and EMU. The package contains six legislative proposals, including a second reform of the Stability and Growth Pact (SGP) and macro-economic coordination (see here). With the media having reported some of the elements during the days before the presentation, coverage in online media today was rather weak with general mainstream media hardly covering the proposals at all. Attention is focused on the rather evident parts of the package such as tougher fines for fiscal sinners, enhanced deficit surveillance and changes in the voting mechanism to actually fine a country.

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After weeks of contradictory statements on the question how to handle Greece, the Heads of State and Government of the EU member states used their informal European Council meeting on February 11^th  for a strong political signal that aimed at calming markets and giving political support to the Greek Prime Minister’s budgetary consolidation efforts and structural reform programme. The subsequent meeting of the EU’s Finance Ministers on February 16^th meanwhile increased pressure on the Greek government for further consolidation, taking the Excessive Deficit Procedure to its next step in which the Finance Ministers issue precise recommendations for Greece and increase surveillance in the country.

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I have been asked to testify in front of the European Parliament's Committee on Economic and Monetary Affairs on the planned financial supervisory structure in the European Union and I had my hearing in Brussels last week. Here is my statement:

Dear Ms. Chairwoman Sharon Bowles, Ladies and Gentlemen,

Let me first thank you for inviting me to testify in front of your committee. I am very honored to be able to provide you with my expertise on the reform of the macro-prudential supervision of the European financial system.

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The Greek case is moving markets – and minds. Over the last few weeks, for instance the German government including Angela Merkel has become a strong proponent of economic policy coordination in the Eurozone. Not only financial markets are nervous these days. Politicians and high officials in particular in the Eurozone are stressed, not only because they wish for nothing less than bailing out Greece, but because they fear contagion to other Euro states such as Spain or Ireland if markets get even more nervous.

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Yesterday’s decision by the Ecofin to water down the Commission’s proposal on the reform of the European Financial Market supervision to make it little more than a teethless tiger is deplorable. But the last word is not spoken – the European Parliament seems set to give the Ecofin a hard time.

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According to recent news reports, the new German coaliton government has found a nice trick which would allow them to cut taxes in the years from 2011 onwards without having to cut spending nor having to borrow more at that time.

Sounds too good to be true? Right. It is not that Merkel and Westerwelle have found a new way to make debts simply go away, but they are rather resorting to an accounting trick. The idea behind all this is to install a special purpose entity which now borrows something like €40bn from the capital market and uses the money in future years to pay for deficits in the social security system. Thus, the recorded deficit for this year would skyrocket, but it would be lower in the years to come, making it possible to meet German constitutional requirements for deficit reduction even if taxes are cut.

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The probable junior partner in Germany’s new coalition, the liberal FDP, on Sunday reached a historically strong result with around 14.6 percent (estimate of 11:54 p.m.) of the votes. For the first time in eleven years, it is set to join the federal government. Given its strong result, FDP chairman Guido Westerwelle will reach out for key portfolios in the upcoming coalition negotiations, including some which play a role in key matters of Germany’s European affairs. Traditionally, the smaller coalition partner in the German government takes the Foreign Ministry. The FDP chairman is hence seen as the most likely candidate for the post of the foreign minister and was actively promoted by senior FDP party figures on election night.

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In our new contribution for Project Syndicate, we argue that the European Monetary Union needs a new stability pact which limits not government budgets, but imbalances in the current accounts of the member states. In such a pact, both deficit and surplus countries would be required to use their fiscal and general economic policies to strive for a rebalancing. If countries are uncooperative, they would be fined. In this way, dangerous trends of external indebtness for single countries can be limited as well as excessive beggar-thy-neighbor policies through revaluation limited.

Read the full column at the Project Syndicate Website here.

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In a new publication for the American Institute of Contemporary German Studies (AICGS) at the Johns Hopkins University in Washington, D.C., I argue that no matter who is going to win the election in Germany in September, Germany will continue to be an obstacle to the reduction of global imbalances. The new constitutional rule on the limits on government borrowing as well as the frame of mind of the main policy makers means that the world will not see a sustainable revival of domestic demand growth in Germany, but a continuation of the Mercantilist strategy of the past decade. You can download the full analysis from the AIGS's website here.

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Last week, the Grand Coalition made sure that their legacy in Germany's economic policy stance will be far beyond the next election on September 27, 2008. After the Bundestag had already voted to amend the constitution and to include a sweeping ban on public borrowing a couple weeks ago, the Bundesrat (the part of parliament which represents the Länder) now also voted for including a more strict ban on public borrowing into the constitution.

Prior to this change, the German constitution had a simple rule: Outside times of "economic disequilibrium", the government was not allowed to borrow more than it was spending on investment.

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