Fiscal compact: read before signing


image9703By Luis Martí, in Madrid | In an understandable effort to correct serious original defects, the European Union has decided to adopt the fiscal compact promised in the European Council declaration of last November 9. This now is presented to us as none other than the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, open for member countries to sign after the January 30 summit. For the German Chancellor this represents a solid step toward a future ‘fiscal union’ (Bundestag, 6 February) that, nevertheless, no one has defined yet.

In fact, each commentator –running the full gamut from the anti-European British press all the way to the German euro-sceptics– criticises the agreement based on pre-conceived ideas. We already know that the United Kingdom washed its hands right from the beginning, and that the Czech Republic will remain on the sidelines as its undeniably anti-European president’s intentions have won the case.

Thus, it might be interesting to, first of all, offer a short ‘briefing for executive directors‘ of a text whose introduction and system could have been much further improved. The Treaty proposes three objectives:

First | fiscal discipline (Title III, fiscal compact properly speaking). The budget should be balanced or in surplus. Two indicators materialise this statement:

1 – structural budget balance, whose deficit can not exceed 0.5% (unless ‘exceptional circumstances’ coincide –including a recession period), or 1% when the country has a low debt/GDP.

Deviations from the indicator: the country must, automatically, design a plan to correct them. The euro zone countries accept beforehand the recommendations issued by the European Commission (except in the case of a “reverse” majority of the Council).

National law: the rule must be transposed into national law, preferably in the constitution itself (as Germany did in 2009 and Spain did in 2011). The breach thereof is subject to the jurisdiction of the European Court of Justice.

2 – relationship between public debt and GDP, maximum 60%. Higher rate must be reduced to an annual 1/20.

Debt issuance programs: each country shall advance it to Commission and Council.

Second | economic policy coordination and convergence (Title IV). Growth through convergence and competitiveness. Every country prior to making any major reform shall subject it to collective discussion.

Third | governance of the euro zone (Title V). A president for the Euro summits, elected by simple majority. The Euro summits are held as informal meetings twice a year, and its president must provide all EU countries with information about them.

Coming into force and legal framework: Signing planned in March and coming into force as soon as twelve euro zone countries ratify it. At the moment it is just an agreement among States, which the parties shall try to incorporate into the Community law within five years.

As with the EU founding treaties, the Treaty includes general application rules –to the extent that the relevant ratifications occur– and norms limited to the euro zone countries.


Many of its points raise legitimate doubts, but this column only ventures a couple of comments on some major problems raised by fundamental criticisms, true “amendments to the whole” of the project just like various recent counter-opinions expressed by Martin Wolf.

The Treaty –the critics say– reiterates the obsession of the Stability and Growth Pact with fiscal imbalances, ignoring the fact that their origin lies in economic misalignments in the private sector, which unleashed the crisis in Ireland and in Spain. It does not add any substance to the Pact, nor are there reasons to believe that the Pact will be respected. If the pact was not respected, it is an unnecessary Treaty.

The first observation is mistaken. The Treaty can not be understood without making reference to the bulk of the regulations relative to budget supervision and economic policy coordination that form a thick package –the six-pack– of Council regulations or Commission directives, dated throughout November 2011, which replaced the Pact and define a whole framework of obligations for all the members of the EU. What must be emphasised when facing the criticism is that the mentioned package includes two regulations – of the Council and the Parliament – that for the first time deal extensively with the issue of detection and correction of the macro imbalances originated in the real economy of the member countries. They are an essential instrument at the service of the objective of the coordination of economic policies of Title IV of the Treaty. The EU now can apply the procedures to adequately identify real estate bubbles or any other asset inflation. It is clear that the EU has learned from the Pact omissions, and it is unfair to accuse it of an inefficiency it has overcome.

The second observation carries a deep charge. If the Treaty essentially reveals continuity, ‘why are we expecting the member countries to comply with its terms if they have not done it so far?’ The answer has to be political. The effectiveness of the Treaty will depend on the degree of commitment assumed by the countries, rather than on the supervisory and sanctioning system. The body of rules –Treaty + six-pack– intends to root a sense of cohesion and interdependence already pursued by the Pact but that the member countries did not initially catch on to as fundamental for the functioning of a monetary area composed by such heterogeneous economic structures that is so far from being ‘optimal’ in Mundell or McKinnon sense. The current proposal is a second opportunity so that the member countries carry into effect the meaning –so far illusory– of coordination of economic policies. That this will be achieved in reality strictly depends on the permanent disposition of the effort in each country to accept unavoidable limitations on sovereignty, depending on the general interest in preserving the single currency. Make no mistake: this political will did not exist during the euro’s infancy, therefore, the new stage must not be seen at all as a quiet return to normalcy after the catastrophe: back to business as usual

John Kay reminds us that neither the US nor the UK – each having experienced institutions– is capable of respecting its own budget discipline rules, thus the vision of the future of the euro zone must be completely pessimistic. Undoubtedly this point threatens to be a serious problem. Avoiding that the threat become real requires, certainly, attitudes whose internal economic cost governments should evaluate before it’s too late.

The rules are not intended to solve the burning problems of the day –as the uneven development of the Greek problem– but rather form a basis to allow the future introduction of solid integration formulas, perhaps including some form of euro-bonds as Holger Steltzner anticipated in a recently highly critical column (FAZ, 29 January). The word is anathematized today in Germany and the reason should be understood: it is unacceptable as a principle to guarantee debts arising from the uncontrolled budget management in other countries. It is not a capricious attitude, but a reaffirmation of the spirit (and the letter of the law) of the a125 of the TFEU.

If the intention of the current German government –which I believe we should make ours, too, regardless of how undefined it is, and precisely, to contribute to its definition– is to walk toward a fiscal union, there are steps that can be taken long before the handing over of sovereign power in budget matters is discussed, and one of them could be the unified issuance of bonds. However, I do not believe we are talking of something that will take place immediately. It will require a prior period during which the economic policies of the euro zone will have developed without friction so that the market and the guarantor countries perceive as insignificant the illiquidity and insolvency risks of all the rest. This only depends on the political commitment of each one among all. If it wavers again or it breaks down, then the negativist critics who today announce that the euro zone shall not survive will have been right.

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.

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