The Euro Summit: No Solutions, New Problems

14 Dec 2011

Prof. Karl Whelan

The Euro Summit: No Solutions, New Problems

Despite all the talk about the “summit to end all summits” and the subsequent drama involving the UK’s veto of a full Treaty change, last Friday’s summit agreement made very little progress in solving the Euro area crisis and has left us with a lot of uncertainty about the legal and political developments of the next few months.

Even against the low expectations that may have been generated by previous summits, the outcome was disappointing. All the more frustrating for countries such as Ireland is that the legal uncertainty generated by this meeting may further fuel already-serious economic problems. 

No Bazooka, Yet

In relation to the Euro crisis, the most notable development was the absence of the much-rumoured “big bazooka”. The most significant concrete proposal was that Europe would provide €200 billion to the IMF (apparently via national country central banks and the ECB).  Given refinancing needs for maturing debt for Italy alone next year of €320 billion, this proposal falls well short of the kind of “firewall” that can credibly prevent a “buyers' strike” and potential default. Other proposals, such as the leveraging up of the EFSF, are being persisted with, despite no evidence of much progress in their implementation to date.

Furthermore, there has been little to bear out the assumption of market participants prior to the summit that the ECB would step in once a fiscal agreement was put in place. Indeed, Mario Draghi, whose earlier comments had greatly encouraged financial markets, explicitly poured cold water on the idea of ECB intervention.

It is hardly surprising that the reaction of the markets to the deal has been cool, with the euro falling sharply and Italian bond yields creeping back up.

I have believed since last summer that Eurobonds were not a feasible way to solve the current crisis and that it would ultimately rest upon the ECB's intervention, most likely in the form of loans to an EFSF-sponsored bank, to ease the debt crisis. Long-time euro-watchers such as Barry Eichengreen also hold this position, though as time passes, the alternative viewpoint of Paul Krugman looks more credible.

New Fiscal Rules

So no big bazooka. Instead, we are getting a “fiscal compact” that is essentially an enhanced version of the Stability and Growth Pact and vaguely worded plans for enhanced co-operation and movement towards a “common economic policy”.

While there is little doubt that many Eurozone countries need to get their public finances on a more stable footing, the fiscal compact is largely an agreement to close the barn door after the horse has bolted. The rules may help to prevent a future fiscal crisis but can’t change the current reality.

Indeed, even as fiscal rules go, these are fairly poorly designed.

Consider, for instance, the requirement that the structural deficit not exceed 0.5 per cent of nominal GDP, which would imply that, over the business cycle, average deficits should not be higher than 0.5 per cent of GDP. As I discussed in this blog post, a country that averages 3 per cent growth in nominal GDP would tend towards a maximum debt-to-GDP ratio of 17 per cent. It may be tempting to attempt to solve debt problems by imposing highly restrictive rules that, if implemented, would almost eliminate public debt. In practice, such rules will be resented as unnecessarily strict and will be more likely to be violated.

Legal and Political Problems Ahead

While it may have done little to solve the immediate crisis facing the Eurozone, the summit has managed to create a series of new problems.

Consider, for example, the situation that the Irish government now finds itself in. The new intergovernmental agreement is likely to require a referendum, for a number of reasons.

– The new requirement that annual structural deficits not exceed 0.5 percent of GDP is to be “introduced in Member States' national legal systems at constitutional or equivalent level.”  Since we have a constitution, this looks as though we need to have a referendum to place limits on structural deficits (a theoretical concept rather than an accounting one) into our constitution.

– The fact that the UK is not participating in this new treaty shows that it is not “necessitated by the obligations of membership”, the terminology used in article 29.4 of the Irish Constitution that can allow new agreements without referenda.  Thus, as my colleague Gavin Barrett from UCD argues, the precedent of the Crotty case suggests a referendum is likely.

– In relation to other articles in the constitution that set down the power of the Dáil (Irish parliament) to decide on the country’s fiscal policies, it will be hard to argue that an as yet unseen treaty that promises new powers for the European Commission to intervene in budgetary affairs as well as new mechanisms to move “towards a common economic policy” does not require constitutional change.

– Given the precedent of referenda for less far-reaching agreements, there will be a strong political argument for the need to have one for this agreement.

It will be very important that other Eurozone member states be careful when discussing the problems faced by countries such as Ireland, for whom ratification of a new treaty will be politically complex.

For all the temptation to present such an agreement as a “yes or no” moment on euro membership (a temptation last seen with Mrs. Merkel’s “ya oder nein” moment) the truth is that there is no clearly defined way to expel a country from the single currency. Beyond the potential of a bullying approach back-firing with the Irish public, a focus on a referendum as a decision about euro membership risks triggering a massive bank run as depositors take flight to avoid the redenomination that is being threatened.

This agreement does little to help solve the crisis. And it places countries like Ireland in a very difficult political corner. Let’s hope our European partners can keep their rhetoric dialled down and perhaps consider how to improve Europe’s image in Ireland prior to any referendum. A deal on the burden imposed by the legacy of Anglo Irish Bank’s debt, as I discussed in a recent column, would be a good place to start.

 

This content forms part of the E View project, which is part-funded by DG Communication of the European Parliament. 

 

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