The political endgame for the euro crisis

Charles Goodhart, Dirk Schoenmaker

14 December 2011

a

A

The euro has a supranational monetary policy framework, while the fiscal side is still national/intergovernmental. We have a central bank president for the Eurozone, but no finance minister. But how could countries possibly cede sovereignty over some aspects of fiscal policy without democratic legitimacy?

We need to fix the political dimension before we can finally solve the financial side of the sovereign and banking crisis. It is not sufficient to elevate the current Commissioner for Economic and Monetary Affairs to Finance Minister status. A full democratic setting – including an elected president of the European Commission – is necessary to complete political union.

Political legitimacy for the Commission president is needed for two reasons:

  • To enforce budget discipline on participating members, to restrict the impact of fiscal spending on the wider Eurozone.
  • To oversee Eurozone banking supervision and resolution, to foster the stability of the Eurozone banking system.

Political union

The Treaty of Lisbon has created a union of democratic states. The EU itself also forms a democracy, albeit an incomplete one with the European Parliament as its main democratic element. The question is how the EU democracy can be further advanced with an elected executive.

The political framework starts with a much-needed Eurozone (EZ) Minister of Finance, as suggested by Trichet (2011). There have been suggestions about the powers that such a position would involve (e.g. Marzinotto, Sapir and Wolff 2011). But a strong, technocratic, finance minister is not sufficient in itself. Proper mechanisms for election and accountability are needed to have the EZ Finance Minister work in a democratic setting. This position would rest inside the European Commission.

National experience shows that the success of any finance minister crucially depends on strong support from the prime minister (and vice versa). Thinking about a democratic political union therefore starts with a President of the European Commission, elected by the citizens of the EU (Goodhart, 2011).

Angela Merkel has now made preparations for such a political endgame. At the recent Christian Democratic party conference (Parteitag, see CDU 2011), a resolution was endorsed proposing an elected President of the European Commission. After election, the President can then form a team, including his or her Commissioner for Economic and Monetary Affairs (i.e. the EZ Finance Minister). The Commissioners will need to be approved in hearings by the European Parliament.

The CDU resolution also suggests reforms to the parliamentary side of political union. It proposes a two chamber system. The current European Parliament would continue to be chosen by European citizens, and form the equivalent of the Bundestag, House of Commons, Tweede Kamer, or House of Representatives in the respective national countries.

A new chamber – comprising the Council of Ministers – would be created and form the equivalent of the Bundesrat, House of Lords, Eerste Kamer or Senate. The central idea of such a two chamber system is that the political discussion would be initially held in the main chamber representing the full electorate, and that a separate “chambre de réflexion” would then represent the interests of the separate member countries.

Powers of the EZ Minister of Finance

The idea of an EZ Minister of Finance has its raison d’etre in the need for enforcement of the Stability and Growth Pact (Trichet 2011). The intergovernmental approach has clearly failed, as EcoFin ministers followed the principle of non-intervention – ministers would not interfere with each other on the understanding that each of them would not be touched when they ran into problems. The EZ Minister of Finance would have full supranational powers to impose sanctions if a country transgresses the fiscal deficit rules.

Nevertheless, the concept of sanctions needs much further thought. Imposing pecuniary fines on a country already in fiscal difficulties does not make much sense. An alternative is to give the EZ Minister of Finance supranational powers to block budgetary expenditures, or to require his or her prior approval of expenditures by transgressing countries.

The EZ Minister of Finance would thus be the counterpart for the ECB president. In any country, the minister of finance and the central bank president are de facto choosing the appropriate monetary-fiscal policy mix. When the central bank is operating on an independent basis, the appropriate mix can emerge tacitly.

Banking

A second power is in the area of European banking. The Internal Market legislation enables banking on a European scale, while supervision and resolution is primarily done at national level, with some loose coordination.

The home country principle of the Internal Market does not suffice for the current large cross-border banks in Europe. During the 2008-9 financial crisis, it was clear that all authorities (both home and host) followed a national rather than a European agenda. To get out of the current setting dominated by national interests, banking supervision and resolution should be put on a European footing (Schoenmaker 2011; Veron 2011). While the chairs of the European banking and resolution authorities can be accountable to the European Parliament, these chairs need a political counterpart in the setting of banking policies and overall accountability. Moreover, the EZ Minister of Finance needs to decide, if needed, on taxpayers’ money for bank resolution.

Two-speed Europe

The EZ Minister of Finance will need budgetary oversight powers only for the Eurozone members. It is therefore likely to start overseeing Eurozone banking supervision. But the ultimate goal should be to operate at the EU level, since the Internal Market for Banking operates EU-wide.

The statement by the EZ Heads of State or Government at their 9 December 2011 meeting provides for a variable geometry (European Council 2011). The new legal framework will encompass the 17 Eurozone members and up to 9 non-Eurozone members. The UK prime minister has exercised its veto and decided not to join.

Nevertheless, financial services policy is as important for the UK (with the City as the premier financial centre for Europe and beyond) as agricultural policy for France. France has informal leadership on agricultural policy. It is difficult to outvote France on agricultural matters. Such a political arrangement could only work for financial services if the UK would be prepared to play the collaborative game (and not to demand unanimity in particular financial services domains, as it did at the December Summit).

The aim of our proposal is to keep the Internal Market on financial services. The financial system can then continue to support the real economy in an efficient way and thus foster economic growth. By contrast, an Alleingang of the Eurozone in financial services would force a split in the EU’s financial system. This may end up in an internationally competitive financial centre outside the “European” framework, and a more traditional financial system inside the “European” framework. This is clearly a lose-lose situation – London may lose some business from its European neighbours, while the remaining European countries face a less dynamic financial system.

Fiscal and legal imbedding

An EZ Minister of Finance without money is like an emperor without clothes. There are proposals to have tax capacity capable of funding a budget of about 2% of European GDP (Marzinotto et al 2011; Goodhart 2011). This 2% should cover most eventualities, including effective stabilisation policies. Yet there may be exceptional circumstances, for example, relating to banking resolution where more is needed (the deep pockets of government).

Examples are:

  • The fiscal backstop to a new European Deposit Insurance Corporation (EDIC).
  • The resolution of one or more large cross-border banks.

In that case, the EZ Minister of Finance should be able to share the burden amongst participating members based on an ex ante burden-sharing arrangement (Goodhart and Schoenmaker, 2009).

In addition to fiscal powers, the new EZ Minister of Finance would need appropriate legal powers. The coordination of budget policies is based on Article 5 of the TFEU (Treaty on the Functioning of the EU), and the rules governing the Excessive Deficit Procedure on Article 126 of the TFEU. After the decision at the December Summit to adopt a variable geometry (European Council 2011), the new legal framework will start outside the EU Treaties. This is similar to the Schengen Arrangement (creating Europe’s borderless Schengen Area), which is a treaty signed in 1985 between five of the ten member states of the European Community.

The Schengen Agreements and the rules adopted under them were, for the EU members of the Agreement, entirely separate from the EU structures until the 1997 Amsterdam Treaty, which incorporated them into the mainstream of EU law. The Council and the Commission are invited to prepare the new legal framework by March 2012.

The new banking supervision and resolution powers could be introduced by regulations, i.e. by standard EU law-making that does not involve changing the Treaties (Schoenmaker, 2011). The new European System of Financial Supervision allows specific powers to be transferred to the European Supervisory Authorities (ESAs). For example:

  • The European Securities and Markets Authority (ESMA) has received the power to supervise directly credit-rating agencies.
  • Similarly, banking directives and regulations could transfer the supervision of large cross-border banks from the national banking authorities to the EBA.
  • In addition, a new European Resolution Authority could be established by a regulation.
  • Finally, a special resolution regime laid down in an EU regulation would ensure application to the European-wide operations of a bank.

Such a regulation would provide a European mandate and override national legislation. This European mandate is crucial to overcome national interests. The Maastricht Treaty assigns, for example, the ECB with the task of monitoring price stability in the Eurozone (instead of the inflation in the participating members). This ensures that both the ECB President (and executive directors) and the national central bank governors focus on Eurozone inflation.

Conclusions

Any complete solution to the euro crisis needs to be political. A technocratic solution will not do. This includes:

  • A strong EZ Minister of Finance with budgetary and banking powers.
  • An elected president of the European Commission.
  • A two chamber parliament representing EU citizens and EU member states.

References

CDU (2011), Starkes Europa – Gute Zukunft für Deutschland, Beschluss, 24. Parteitag der CDU Deutschlands, Leipziger Mess, 13-15 November.
European Council (2011), Statement by the euro Area Heads of State or Government, 9 December, Brussels.
Goodhart, Charles (2011), Europe: After the Crisis, DSF Policy Paper No. 18, Duisenberg School of finance, Amsterdam.
Goodhart, C. and D. Schoenmaker (2009), Fiscal Burden Sharing in Cross-Border Banking Crises, International Journal of Central Banking 5, 141-165.
Marzinotto, B., A. Sapir and G. Wolff (2011), What Kind of Fiscal Union?, Bruegel Policy Brief, Issue 2011/06, Bruegel, Brussels.
Schoenmaker, D. (2011), Cross-Border Resolution in Europe, DSF Policy Paper, Duisenberg school of finance, Amsterdam, forthcoming.
Trichet, Jean-Claude (2011), Building Europe, Building Institutions, Speech on receiving the Karlspreis, Aachen, 2 June.
Veron, N. (2011), Banking Federalism is Key to Eurozone’s Survival, Emerging Markets – G20 Edition, November 3.
 

a

A

Topics:  EU institutions

Tags:  European parliament, EZ crisis, EZ political integration

Emeritus Professor in the Financial Markets Group, London School of Economics

Professor of Banking and Finance at the Rotterdam School of Management, Erasmus University Rotterdam; Senior Fellow, Bruegel; and Research Fellow, CEPR

Events