The answer lies with the expected gain from further integration, chief economist for France, Laurence Boone, at Barclays Capital writes in an article published by the EVRO Intelligence. Coordinating fiscal exit strategies would be a good economic argument for further fiscal integration, she argues.
“The financial difficulties of Greece have exposed divergences of views within the union.”
Seven years are supposed to be critical for a wedding; it will be ten years for the common currency. Two issues are at the centre of the current frictions across the euro area. There is a short-term issue, related to fiscal difficulties, and there is a longer term issue which is related to “euro imbalances”. In effect, both ask the same question, one that policy makers would rather avoid: more fiscal integration or not?
The answer lies with the expected gain from further integration, chief economist Laurence Boone writes.
On the short-term side, the financial difficulties of Greece have exposed divergences of views within the union. On the one hand, virtuous countries would not like to pay for Greece an
d would rather see Greece pay the price of previous fiscal profligacy. Should Greece fail to adjust, either because the adjustment is too demanding or because it does not want to proceed through a painful adjustment, the country would thus have to default or reschedule its debt.
It is interesting to see from past programs of the International Monetary Fund over the past 20 years that they are a lot more indulgent than those of the EU. The IMF has a strict and transparent process for setting-up the conditions of assistance, in terms of interest rate, amount, and time period. The IMF interest rate for loan would be benign: from 1.25% to 4.25% depending on the tranches of money being lent and the length of the loan, typically from 3 to 5 years.
The amount is expressed in terms of quotas at the IMF, but the IMF has proved flexible enough to go well over the defined amount when necessary.
In addition, the IMF has the means to finance Greece over the next couple of years, especially assuming that the IMF presence would ease the costs of adjustment, as Greece’s monitored adjustment would imply a rapid decline in its funding needs. In this scenario, there is little need for further integration.
On the other hand, some euro member countries or actors seem to think that the euro area is an entity beyond EMU, a political entity, and as such should be able to deal with such issues.
As a result, the IMF should not necessarily be called to deal with an internal problem, but fiscal transfers would be allowed – or not – by fellow euro members – a bit like Switzerland, the United States or any other federation. In practice, however, federations tend to be more politically integrated.
For example in the United States, the general government finances can be equally split between federal, state and the local levels, implying a more fiscal transfers and integration than in the euro area.
So, even when defaulting on its local debt, a US State is still benefiting from federal transfers. Swiss cantons are not allowed to be in disequilibrium either.
From this angle, fiscal integration thus means more money in a common pot through higher transfers, and less sovereignty within the state.
The idea of bilateral loans, the European Monetary Fund or a common debt agency reflects the idea that there should be more fiscal integration across euro countries. Indeed, the “fathers” of the EMF reckon it would require a budget at least equivalent to the current EU budget, while a common debt agency, as suggested by the Belgium prime minister, would imply some form of fiscal solidarity and thus transfers. Accordingly, there would be a supra-national entity that would then ensure that “federal” fiscal measures are enforced.
In this scenario, the economic gains consist of lower interest rates as a result of the solidarity but also from higher transfers across member states that would smooth business cycle fluctuations.
In the longer-term, there is a similar dilemma regarding structural policies.
On the one hand, wage restraint and fiscal restraint would bring competitive advantages and savings for the future.
On the other hand, some argue that if all euro countries were to behave this way, the result would be deflation and depression, as there would be no internal demand growth any more.
This argument is fallacious: although intra-euro area trade has reached a high point, euro countries still trade goods, services and capital with the rest of the world.
The euro area countries’ share of trade with the reste of the world, in terms of gross domestic product, is 30%, and the EU is the first exporter and importer of goods and services worldwide, excluding internal trade.
As a result, current account imbalances do not need to be solved within the euro area, as Charles Wyplosz has recently argued.
On the other hand, Germany would benefit from increased demand for its products from its euro partners, should it manage to exit more quickly from both the fiscal trap and from the growth trap. However, this is neither an argument for undoing Germany’s competitiveness gains, nor against fiscal virtue.
It is an argument for coordinating fiscal exit strategies. This, in turn, would be a good economic argument for further fiscal integration.
By Laurence Boone.
Original article at: evrointelligence.com.
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