A Dozen years after
the Delors Committee produced a plan for Economic and Monetary Union, the euro
finally becomes a reality for 300 million Europeans this January. The technical
difficulties of introducing notes and coins will ensure a nervous few weeks
for euro-zone businesses and policy-makers alike. Yet a much bigger challenge
now hangs over the embryonic currency. For as Europe suffers a sharp economic
downturn, the decision-making system in the euro-zone will come under increasing
scrutiny.
Even before the events of September 11th, the euro-zone economy was slowing.
Germany entered a recession midway through 2001. Since September 11th, consumer
and business confidence across the euro-zone has plummeted even further. The
European Commission now estimates that euro-zone GDP will increase by just 1.3
per cent in 2002, compared with a previous forecast of 2.9 per cent.
If the economic downturn is prolonged, doubts about the ECB's mandate, which
is narrowly focused on beating inflation, are likely to resurface. Euro-zone
governments have been careful not to criticise the ECB in public, not wishing
to undermine confidence in the new currency during the vital changeover period
to notes and coins. Nevertheless, tensions between the ECB and the Euro Group,
the informal forum for euro-zone finance ministers, are never far from the surface.
At the Ghent European Council in October, one part of the draft conclusions
specifically called for the ECB to cut interest rates, though this was watered
down in the final text.
The subject of reforming the ECB is likely to move up the agenda anyway in 2002,
as the debate on the EU's institutions post-enlargement develops. If the perception
grows that the ECB has not cut rates swiftly enough to head off a full-scale
recession, some governments, including probably France, are likely to begin
a concerted campaign to strip the Bank of its sole right to set the inflation
target.
For its part, the Euro Group faces a double challenge. First, it will need to
help the ECB maintain public confidence in the euro during the changeover period.
Its track record in presenting a coherent and united approach to economic policy
is not strong. If individual finance ministers upset the markets or undermine
consumer confidence in the coming months, the debates over whether the Euro
Group should become a formal institution, and whether it needs some sort of
'High Representative' to lead it, will intensify.
Second, a sharp economic downturn is likely to prove the first serious test
of the euro-zone governments' commitment to budget discipline. EU leaders have
already made clear that the Stability and Growth Pact will not be amended to
give governments more flexibility in coping with the downturn - though they
did recognise that budget deficits may need to rise modestly in the short run.
The pact prescribes the actions that the Council of finance ministers may take
against governments which breach the Maastricht treaty's 3 per cent budget deficit
limit, including the possibility of fines. Ironically, Germany - which was instrumental
in establishing the pact's strict rules -is likely to run a deficit perilously
close to this ceiling. The European Commission estimates the German budget deficit
will total 2.7 per of cent of GDP in 2002.
EU governments have given themselves greater fiscal flexibility by revising
the system under which they agree every year to 'Broad Economic Policy Guidelines'.
Unlike the Stability and Growth Pact rules, these guidelines are not formally
binding. They provide a more detailed annual analysis of the governments' efforts
to bring their budgets into balance, and also cover a wide range of structural
economic policies.
The EU has begun to revise this system so that targets are no longer based on
a straight measure of budget deficits -which are vulnerable to the whims of
the economic cycle - but rather on the structural, or underlying, budgetary
position. Once this new principle becomes established in the Broad Economic
Policy Guidelines, it should then be extended to ensure that any breach of the
Stability and Growth Pact rules is also examined in structural terms.
Reform on these lines would not unsettle the financial markets, which already
accept that the existing rules are untenable. Rather it would suggest that Europe's
leaders are prepared to allow the euro-zone system to evolve. Only then will
the single currency finally come of age.
Alasdair Murray is director of the economics and social policy unit at the CER.
