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Europe eyes tougher fiscal discipline

By Pallavi Aiyar
May 13, 2010 10:48 IST
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Following hot on the heels of Monday morning's shock announcement of a trillion dollar safety net for an increasingly shaky euro, the European Commission on Thursday announced a set of proposals aimed at increasing the economic and fiscal coordination of European Union member states.

The new measures, if implemented, would move beyond immediate fire fighting and instead begin to redress the fundamental imbalances and contradictions within the euro zone that allowed an emergency like the Greek sovereign debt crisis to arise in the first place.

The fiscal drama that has unfolded across the region over the last several months has not only wrecked havoc in international currency and stock markets but has also revealed the political dimensions to this economic crisis.

 The EU's credibility has proven sharply circumscribed by the irrationality at the heart of its workings. The euro zone for example is a group of 16 member states that comprise a monetary union with a common currency but without a matching fiscal or political union.

Thus, although the European Central Bank sets interest rates for the euro zone, it does so in a vacuum, with constituent governments retaining control over fiscal and economic policy.

While the massive bailout package announced earlier this week has gone some way in calming the markets in the short term it has left unaddressed this contradiction as well as others such as the yoking together of very disparate economies like Greece and Germany in a single union.

It is these underlying issues that the commission is now taking aim at. Speaking to reporters at a press conference in Brussels the President of the European Commission Jose Manuel Barroso announced, "Europe has dealt with the immediate emergency but we must also show we are serious about the more fundamental reforms needed. We must now get to the root of the problem."

The Commission's proposals revolve around three main sets of measures.

One seeks to increase the ability of European countries to supervise each other's national budgets before they are passed by parliaments, a big step toward joint administration of fiscal policy.

While they would not have the power to force a nation to rework its budget, they would be able to exert pressure to make the budget's assumptions about economic growth, inflation and interest rates as realistic as possible.

The second set of measures is intended to move beyond fiscal surveillance to monitoring macroeconomic imbalances and competitiveness, in other words the large current-account surpluses in countries such as Germany compared with the growing deficits in southern European nations.

Mr Barroso stressed that at a macroeconomic level "both competitiveness and domestic demand" were key to ensuring balance, a dig at Berlin's reluctance to agree to the idea that increasing German demand is also one part of the solution to Europe's current economic woes.

The third measure is the establishment of a version of a European Monetary Fund or EMF that would take the recently announced trillion dollar kitty and make it into a permanent "crisis resolution mechanism."

The details of the new mechanism remain bare boned, but Mr Olli Rehn, the EU's monetary affairs commissioner said it would be "a last-resort mechanism of financial assistance in the form of loans, with interest rates that would be so unattractive that no one would want to use it voluntarily."

The commission also said it wanted to take more aggressive punitive steps against member states that violate the EU's fiscal rule book, the Stability and Growth Pact, which generally requires national governments to keep their deficits below 3% of gross domestic product.

It is not clear yet whether the commission's proposals are intended to apply to the entire 27 member European Union or only the smaller group of eurozone countries.

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Pallavi Aiyar
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