With the recent appointment of a former European commissioner as head of Italy, a former vice president of the European Central Bank in Greece and the arrival of new leadership in Spain, the victory of the German path to save the euro was made even more explicit during last week’s summit.
While welcome that the euro countries are pushing for further integration, the problems with a plan dominated by long-term structural change will remain. With bond rates still close to an unsustainable level for both Italy (6.85 percent) and Spain (5.83), events may trigger a serious deviation from the proposed path and force leaders to accept interventions while facing issues of moral hazard.
The solutions proposed at last week’s conference can be divided into short and long-term aspects.
The long-term aspects take the form of a fiscal compact which states that government budgets must be balanced or in surplus and will be regarded as such if annual structural deficits do not exceed .5 percent of nominal gross domestic product. This rule is required to be implemented on a constitutional or similar level and the European Court of Justice will be tasked with verifying that countries live up to it.
Beyond this, the summit focused on ways to enforce deficit reduction plans and future monitoring of national budgets. What is likely to come into effect is the ratification of national budgets by the European Commission before they move on to national governments for approval.
These proposals, while still far from concrete, will be supported by further fiscal integration and a deepening of the nature of cooperation between the European states.
In the short term, the latest agreement sees funding going to International Monetary Fund of about €200 billion to contribute to the crisis. This could be seen in the light of the failure to generate outside participation for Europe’s temporary bailout fund and it is hoped that non-European countries contribute to the fund once administered by the IMF. This may well provide resources that can be easily deployed without the difficult legal and political battles within the European Union.
Perhaps equally important, the proposals reaffirmed the notion that private sector losses on Greek sovereign debt were an exceptional circumstance that would not be considered in any future date for any other country. This may just be the words of chastised politicians and complications may arise as the IMF is always considered a preferred creditor, meaning that the money owed to the IMF is repaid first.
What shines in its absence is a well defined role for the European Central Bank. Given the growth numbers forecast for the eurozone, the pressure put on the currency union as a whole by ratings agencies and the size of debt financing for major countries in the years ahead, it is very likely that the central bank will need to step in for one reason or the other in an ad hoc fashion that may have dramatic consequences in the market.
This could change the longer term approach with its fiscal and political consequences. The framework has thus a considerable flaw. Of course, the absence of any inclusion of the ECB may be a way of making it appear that the bank acts independently of the political process, something which is especially important with the arrival of a new central bank president who has yet to prove its inflation fighting credentials.
What could prove to be of greatest consequence is that this summit gave tentative signs that European countries will now actively need to answer the question of what European integration looks like and how much of it they are willing to tolerate. In this regard, Britain has already done much damage to the integration process by refusing to participate in last week’s proposals. Three other countries have also gone to their respective parliaments for final approval.
Those are sobering actions that could have wide consequences on the future political map of Europe.