Other than Germany and France the European countries seem to be in a holding pattern following the agreements between Germany and France. These two countries seem to be driving the crisis and the future of the Euro. After saving the Euro more than once, the last summit made clearer the two paths that Europe may follow. On one side, France is pushing for extended expenditure to deal with the crisis (and future crises); and on the other hand, Germany is pushing for more government austerity to keep debt at manageable levels.
The idea that a committee or organism in Europe should approve fiscal deficits for the Euro countries finally marks a concern on one of the key problems of the European crisis. Undoubtedly, there can be some benefits from this. For starters, even if the rule is not going to be followed, there is a political cost for breaking the rule, and it can marginally contribute to keep budgets in place. If the norm is completely ignored, then it adds nothing, but also does not make things worst.
But there are some other aspects that may not necessarily be positive.
Fiscal stability has to do more with political will than with norms. Countries around the world do not hesitate to influence their central banks’ behavior into extending loans to their treasuries or following monetary policies that will benefit a political cycle or objective. There is no reason to think that Europe is an exception; the crisis shows just the opposite. Even after World War I, political decisions had a strong effect on how central banks behaved under a gold exchange standard, ultimately resulting in the collapse of the system. The new monetary regime of fiat currencies did not make fiscal deficits and large debts more difficult but, on the contrary, facilitated them for governments. Central banks were born more due to fiscal crisis than inherent banking crises. So the problem is not how to help these fiscal crises happen, but how to avoid them.
For this reason the European future does not rest so much on an integration of labor and tax policy as it does on the political will to keep the budget under control. The financial health of a condominium does not depend on the labor and tax integration of their units, but on each household not taking more loans than it can afford to repay. If this is in place, the more liberties each household has, the better they can adapt their means to their ends.
Without the specifics, it is hard to tell how binding the budget rule will be. Is it going to be automatic? Or, for instance, will it be for countries, that share France’s ideas, to decide if fiscal budgets in other countries should be allowed. Or, would it be on countries that share Germany’s position? In a group full of countries that broke the rules they agreed to follow already, namely the Maastrich treatise, to hope for efficient control to come from these same member may not be convincing enough to bring back investments and households confidence in their banking institutions.
Just as the Fed’s policy has been recognized with the Greenspan Put, the Euro’s policy could be recognized with the German Put. European banks did not have to worry too much about their lending strategy. If they became insolvent, they’d be bailed out by their governments. If the countries became insolvent, then Germany would save them; to let the Euro fall would be too costly.
It is not agreements, but facts and attitude which reveal the level of commitment and which are believed to be the rules of the game. If there were no expectations of bailouts, then European banks would not have lent 750 billion euros to the worst standing countries. And it is this crucial aspect that divides France and Germany’s positions. France’s ideal will result in concentrating and distributing the cost among taxpayers when a crisis happens, while Germany prefers to force budget stability to other European countries. Economic policy is driven by politicians, not by the rules in place; the rules impose limits on the policy makers, but the politicians are the ones that follow one or another economic policy.
Germany’s idea of penalties for countries that do not comply with budget requirements is a first step in rightly diagnosing the problem. Probably it took too much time for this to come to surface as a key aspect. But how this is put into practice may result in positive or negative effects. If the result is another Maastrich treatise that will not be followed (betting on the fact that Germany will be cornered and forced to save the other countries), then it does not solve the underlying problem and can result in a higher bureaucratization of the European countries.
Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.