Keep the IMF Out of Europe

Mario I. Blejer and Eduardo Levy Yeyati

2011-12-04
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BUENOS AIRES – A short-lived rumor recently suggested that the International Monetary Fund was putting together a €600 billion ($803 billion) package for Italy to buy its new government about 18 months to implement the necessary adjustment program. Except for the magnitude of the package, this sounds no different from a standard IMF adjustment program – the kind that we are accustomed to seeing (and criticizing) in the developing world. But there is one crucial difference: Italy is part of a select club that does not need outside rescue funds.
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So far, programs for the eurozone periphery have been spearheaded and largely financed by European governments, with the IMF contributing financially, but mainly acting as an external consultant – the third party that tells the client the nasty bits while everyone else in the room stares at their shoes.
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By contrast, the attempt to crowd multilateral resources into Europe was made explicit by eurozone finance ministers’ call in November for IMF resources to be boostedpreferably through debt-generating bilateral loans,– so that it could “cooperate more closely” with the European Financial Stability Facility. That means that the short-lived story of Italy’s jumbo IMF package, which was to be funded largely by non-European money, can be regarded as a game changer: while Italy may never receive such a package, Europe, it seems, is determined to resolve its problems using other people’s money.
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There are at least three reasons why the IMF should resist this pressure, and abstain from increasing its (already extremely high) exposure to Europe.
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First, and most obviously, Europe already has its own in-house lender of last resort. The European Central Bank can make available all the euros needed to backstop Italy’s debt. And printing them would only offset, through mild inflation, the effects of the otherwise Draconian relative price adjustment that is taking place under the corset of the common currency.
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So it is puzzling that some observers have saluted the IMF’s involvement as a virtuous effort by the international community to bring the listing European ship to port. Why should the IMF (or, for that matter, the international community) do for Europe what Europe can but does not want to do for Italy? Why should international money be mobilized to pay for European governance failures?
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And if, as appears to be the case, Germany is playing a dangerous game of chicken with some of its eurozone partners, why should the cost be shifted to the IMF for the benefit of Europe’s largest and most successful economy? Letting the ECB off the hook in this manner would simply validate for Europe as a whole the same moral hazard feared by German and other leaders who oppose ECB intervention.
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The second reason to avoid IMF intervention in Europe is that lending to a potentially insolvent country has serious implications for the Fund. For starters, taking the IMF’s preferred-creditor status at face value, an IMF loan would entail substituting its “non-defaultabledebt for “defaultable debt with private bondholders, because the Fund’s money is used primarily to service outstanding bonds.
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As a result, a group of lucky bondholders would be bailed out at the expense of those that became junior to IMF debt and remained highly exposed to a likely restructuring. Since a “haircut” can be imposed only on whatever is left of the defaultable private debt, the larger the IMF share, the deeper the haircut needed to restore sustainability.
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For the same reason, IMF loans can be a burdensome legacy from a market perspective. Because they represent a massive senior claim, they may discourage new private lending for many years to come.
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This brings us to the third reason why the IMF should stay out of Europe’s crisis: what if Fund seniority fails? The implicit preferred-creditor status is based on central-bank practices that establish that the lender of last resort is the “last in and first out.” It is this seniority that enables the IMF to limit the risk of default so that it can lend to countries at reasonable interest rates when nobody else will. This works when the IMF’s share of a country’s debt is small, and the country has sufficient resources to service it.
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But seniority is not written in stone: poor economies that are unable to repay even the IMF are eligible for debt reduction under the Heavily Indebted Poor Countries program, and 35 have received it since the program was established in 1996. What would happen if, in five years, Italy were heavily indebted to the IMF? What if private debt represented a share so small that no haircut would restore sustainability, forcing multilateral lenders to pitch in with some debt relief?
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The IMF’s seniority is an unwritten principle, sustained in a delicate equilibrium, and high-volume lending is testing the limit. From this perspective, the proposal to use the IMF as a conduit for ECB resources (thereby circumventing restrictions imposed by European Union’s treaties), while providing the ECB with preferred-creditor status, would exacerbate the Fund’s exposure to risky borrowers. This arrangement could be seen as an unwarranted abuse of Fund seniority that, in addition, unfairly frees the ECB from the need to impose its own conditionality on one of its members.
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It makes little sense for the international community to assume that unnecessary risk. Let us hope that the IMF’s non-European stakeholders will be able to contain the pressure. The solution for Europe is not IMF money, but its own.
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Mario I. Blejer is a former governor of the Central Bank of Argentina and former Director of the Center for Central Banking Studies at the Bank of England. Eduardo Levy Yeyati is Professor of Economics at Universidad Torcuato Di Tella and Senior Fellow at The Brookings Institution.
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How to tackle America’s lost decade

Mort Zuckerman

December 5, 2011



News that the US unemployment rate has fallen 0.4 percentage points and that we have created 120,000 jobs is better tidings than of late, but we need to do much better: just to match population growth we need to create at least 150,000 jobs a month.

For hiring to occur at a pace that would support recovery, we would need at least 500,000 more hires per month. Instead, payrolls today are more than 7m shy of where they were when the Great Recession began.
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For American workers, these are the worst times since the depth of the Great Depression. The unemployment rate, the highest and most sustained in seven decades, improved last month primarily because more than 300,000 people left the labour force.

And the situation is even grimmer than suggested by the dismal statistics, calculated from a base of only 60,000 families. Analysts have concluded that the combined unemployment and under-employment rate is slightly above a staggering 20 per cent of the labour force.
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Worse, 40 per cent of the jobless have been out of work for six months or more, compared with 10 per cent in 2007. The average period of unemployment now exceeds 26 weeks, well above the previous peak in July 1983 of just 21.2 weeks. This is critical because the longer that people of any age are out of work, the less likely they are to find another job.
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Most of the activity in the labour market today reflectschurn”, the continual process of replacing workers, which is not the same as expansion. High churn generally means that workers are moving from declining sectors to better jobs in growing sectors that pay higher wages. That sounds good, but here is another dismaying trend. In previous recessions, around 1m more Americans every month moved to better jobs. This means that almost 35m Americans are trapped in jobs they would have left in better times.
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But what of the recent headlines suggesting job growth has recently improved? Again, there is no silver lining. The apparent improvements result primarily from the decline in the number of layoffsdown from 2.5m per month in February 2009 to 1.5m two years later – rather than from increased hiring.
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The Great Recession has shown employers they can do with fewer workers than before, aided by technology and by agencies that allow them to hire temps almost instantlyreducing the need to hire in anticipation of a pick-up in business. Companies know they need to come up with a newer business model to weather a long-term downturn. Predictably, a lot of jobs have also gone overseas.
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The outlook is bleak. Over 20 per cent of companies say that employment in their firms will never return to pre-recession levels.
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Another 40-plus per cent say revenues would have to rise around 40 per cent to return to pre-recession employment levels. Moreover, most of the new jobs available don’t match the pay, the hours or the benefits of the positions that vanished during the recession. Millions of Americans face a lost decade, living from paycheck to paycheck, struggling to pay their bills, having to borrow money and go deeper into debt.
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Who, among the contenders for the White House, has a remedy for this catastrophe? Clearly, this dysfunctional Congress offers no hope until after 2012. Yet we must reverse the decline in American education that has left workers less able to compete in the new world. Skills, not muscle, are the only reliable path to high-wage jobs, in an era when technology and globalisation allow companies to make new investments in regions where labour is cheap.
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We also need to approve many more H1B visas to permit highly educated science graduates to take work in engineering and technology. Contrary to popular perception of immigrants, these are people who would create jobs rather than take them. And we should rationalise the stumbling process of certifying patents in order to unleash thousands of start-ups, the single greatest source of new employment.
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Greater certainty over policy would also help the economy. A metric devised by economists at Stanford University and the University of Chicago shows that policy uncertainty accounts for about 2.5m jobs lost. They assert there is a widespread view in business that the healthcare bill makes it burdensome to hire, underscoring how political uncertainty has made it more difficult to plan ahead. The National Federation of Independent Business asked small businesses their biggest problem. Sixteen per cent of small businesses cited “government requirements and red tape”.
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Finally we need to invest in a national infrastructure bank. We ought to undertake new projects of the kind that built America. But we are not even keeping up with repairs – which will cost much more when our bridges, roads, dams, schools and sewage systems collapse. We look askance at the Europeans, but Washington is a graveyard of American dreams.


December 4, 2011 7:45 pm

Debt crisis lessons from Latin America

By John Paul Rathbone



It is only vanity that makes anyone believe they are special or “different”. Asia didn’t think Latin America’s long history of financial crises held many useful lessons in 1997; it did. The same is true of Europe. It risks falling victim to the same vanity today.

Take UK prime minister David Cameron’s much toutedbig bazooka”. In 1980s Latin America, such comprehensive packages were simply known as “el paquete”. Of course, “el paquete” is only the beginning of the end of a crisis. The real challenge is implementation. This requires leadership.

Technocratic governments (pace Italy and Greece) can work. Fernando Henrique Cardoso, for example, was an academic before he became Brazil’s finance minister and twice president. But bear in mind that Mr Cardoso had a popular mandate. Without that, any government is just a caretaker.

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Argentina is a case in point. In 2001, it ran through a series of governments before triggering the world’s then-biggest default ($100bn; so small compared to Italy’s €1.9tn bond market). Even the brilliant economist Domingo Cavallo failed to turn the tide. To restore competitiveness without breaking Argentina’s euro-like currency peg, he engineered a “synthetic devaluation”. Across-the-board export subsidies and import duties came straight out of the textbooks, but didn’t work. Just as they often do in Europe today, investors saw the country’s debt dynamics still working against it.
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Default fears led to higher bond yields, which led to lower growth and smaller government revenues. This made default more likely in a process that soon became self-fulfilling. After three years of recession, much of southern Europe may already be at this point.
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Even loan support from a multilateral – be that the International Monetary Fund or the European Central Bank – can make matters worse. Why? Because one condition of their help is seniority in a sovereign’s debt structure. This converts private investors into “junior bond holders”. Large official interventions can thus produce the opposite of what they mean to do: an investor rush for the exit.
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The next stage is all too familiar. Citizens also withdraw their savings before they are converted into devalued pesos, drachmas or liras. A bank run ensues. To prevent a collapse of the payments system, the government announces a devaluation – often over a long weekend. The next day, all hell breaks loose.
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These scenes are not out of the question in Europe, and to prevent them, a workable plan is required. Another pre-condition for success: it cannot be seen to be imposed from abroad. Without national support, failed adjustment plan follows failed adjustment plan.
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Fresh money to support each new package is loaned under the rubric: “extend and pretend”. Finally, a plan gains traction. But in the intervening period, strange political fauna can emerge. This was particularly true in Latin America, where democracy was then only ankle deep. Yet is it odd that the new Italian defence minister is a military man rather than a civilian? Spanish democracy is less than seven years older than Brazil’s, and unified Italy is two-thirds the age of most Latin republics.

Finally, of course, bear in mind that the adjustment is very painful. Latin America’slost decademeant years of falling real wages and rising unemployment. As social unrest grows, old scapegoats are often resurrected. In Latin America, with its colonial history, the backlash was against the “Washington Consensus”. In Europe, where Germany is the banker, it may be 20th-century history.
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But rising anger is hardly surprising. When has a debtor ever said anything nice about its creditor?

Europe, of course, is not Latin America. If anything it is in a worse situation. It is more indebted and probably less able to stomach tough adjustment programmes. “They don’t know how to suffer,” Ernesto Zedillo, the former Mexican president, has said of southern Europe.
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European banks are also part of the crisis, which is as much a problem of over-lending as over-borrowing. At least in Latin America, the banks were mostly abroad. Europe should have one factor in its favour. With stronger institutions, it should reach the right solution faster. But higher economic costs always follow poor and tardy policymaking.
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The writer is the FT’s Latin America editor
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Copyright The Financial Times Limited 2011.


HEARD ON THE STREET

DECEMBER 5, 2011, 6:04 A.M. ET

A Dialogue of the Deaf on the Yuan

By TOM ORLIK



When it comes to the yuan, politicians say one thing and the market says another.

In China, confidence in yuan appreciation has evaporated. The yuan trades in a tightly controlled band, with space to move just 0.5% above or below the central parity with the dollar on any given day. Four times in the last four trading sessions it has traded down to the bottom of its band.
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[CHINAHERD]
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There's more negative sentiment in the yuan forward market, which is pricing in 0.7% depreciation against the dollar in the year ahead. The offshore yuan, which is freely traded, has fallen below its onshore cousin. Signs that speculative capital has started to leave China also suggest investors no longer regard the yuan as a one-way bet.
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This doesn't mean investors believe the Chinese currency is actually overvalued. Rather it reflects the view that the Chinese government is poised to slow the pace of appreciation. There's good reason for that. Exports are already falling and will fall more in the months ahead as the euro-zone crisis rumbles on. The high inflation that drove Beijing to more rapid appreciation in the first half of the year is in remission.
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The U.S. has done pretty well on the exchange rate in the past year. Nominal appreciation of 5% plus higher inflation in China than the U.S. gives real appreciation of around 7% - not too shabby. But don't expect to hear that view in Washington, with unemployment still high and politicians gearing up for an election year.

Signaling the resumption of hostilities, U.S. President Barack Obama said in November that the yuan remained as much as 25% undervalued. Republican rivals, meanwhile, are taking the administration to task for failing to extract more concessions from Beijing. Republican presidential candidate Mitt Romney is promising to designate China a currency manipulator and impose countervailing duties on Chinese goods. With his main rivals on the offensive, it will be difficult for Mr. Obama to appear weak on the issue.
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The stage is set for a difficult 2012 in U.S.-China economic relations. Washington will raise the rhetorical temperature. But if Chinese exports continue to deteriorate don't bet on that having any impact on Beijing's plan for the yuan. Real appreciation of 7% in 2011 might not have been enough to make U.S. politicians happy. In 2012, that number could look like a distant dream.
 
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December 4, 2011

Send in the Clueless

By PAUL KRUGMAN


There are two crucial things you need to understand about the current state of American politics. First, given the still dire economic situation, 2012 should be a year of Republican triumph. Second, the G.O.P. may nonetheless snatch defeat from the jaws of victory — because Herman Cain was not an accident.

Think about what it takes to be a viable Republican candidate today. You have to denounce Big Government and high taxes without alienating the older voters who were the key to G.O.P. victories last year — and who, even as they declare their hatred of government, will balk at any hint of cuts to Social Security and Medicare (death panels!).

And you also have to denounce President Obama, who enacted a Republican-designed health reform and killed Osama bin Laden, as a radical socialist who is undermining American security.

So what kind of politician can meet these basic G.O.P. requirements? There are only two ways to make the cut: to be totally cynical or to be totally clueless.

Mitt Romney embodies the first option. He’s not a stupid man; he knows perfectly well, to take a not incidental example, that the Obama health reform is identical in all important respects to the reform he himself introduced in Massachusetts — but that doesn’t stop him from denouncing the Obama plan as a vast government takeover that is nothing like what he did.

He presumably knows how to read a budget, which means that he must know that defense spending has continued to rise under the current administration, but this doesn’t stop him from pledging to reverse Mr. Obama’s massive defense cuts.”

Mr. Romney’s strategy, in short, is to pretend that he shares the ignorance and misconceptions of the Republican base. He isn’t a stupid man — but he seems to play one on TV.
       
Unfortunately from his point of view, however, his acting skills leave something to be desired, and his insincerity shines through. So the base still hungers for someone who really, truly believes what every candidate for the party’s nomination must pretend to believe. Yet as I said, the only way to actually believe the modern G.O.P. catechism is to be completely clueless.

And that’s why the Republican primary has taken the form it has, in which a candidate nobody likes and nobody trusts has faced a series of clueless challengers, each of whom has briefly soared before imploding under the pressure of his or her own cluelessness. Think in particular of Rick Perry, a conservative true believer who seemingly had everything it took to clinch the nominationuntil he opened his mouth.

So will Newt Gingrich suffer the same fate? Not necessarily. Many observers seem surprised that Mr. Gingrich’s, well, colorful personal history isn’t causing him more problems, but they shouldn’t be. If hypocrisy is the tribute vice pays to virtue, conservatives often seem inclined to accept that tribute, voting for candidates who publicly espouse conservative moral principles whatever their personal behavior. Did I mention that David Vitter is still in the Senate?

And Mr. Gingrich has some advantages none of the previous challengers had. He is by no means the deep thinker he imagines himself to be, but he’s a glib speaker, even when he has no idea what he’s talking about. And my sense is that he’s also very good at doublethink — that even when he knows what he’s saying isn’t true, he manages to believe it while he’s saying it. So he may not implode like his predecessors.

The larger point, however, is that whoever finally gets the Republican nomination will be a deeply flawed candidate. And these flaws won’t be an accident, the result of bad luck regarding who chose to make a run this time around; the fact that the party is committed to demonstrably false beliefs means that only fakers or the befuddled can get through the selection process.

Of course, given the terrible economic picture and the tendency of voters to blame whoever holds the White House for bad times, even a deeply flawed G.O.P. nominee might very well win the presidency. But then what?

The Washington Post quotes an unnamed Republican adviser who compared what happened to Mr. Cain, when he suddenly found himself leading in the polls, to the proverbial tale of the dog who had better not catch that car he’s chasing. Something great and awful happened, the dog caught the car. And of course, dogs don’t know how to drive cars. So he had no idea what to do with it.”

The same metaphor, it seems to me, might apply to the G.O.P. pursuit of the White House next year. If the dog actually catches the car — the actual job of running the U.S. government — it will have no idea what to do, because the realities of government in the 21st century bear no resemblance to the mythology all ambitious Republican politicians must pretend to believe. And what will happen then?       


Germany is winning the debate on fiscal union

December 4, 2011 6:36 pm

by Gavyn Davies


The leaders of the eurozone have finally reached crunch time. This is the week in which Angela Merkel’s grand bargain” is due to reach fulfillment at the European summit.
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On one side of the bargain, the eurozone will be required to accept Germany’s demand for “fiscal union”. On the other side, Germany will agree to the provision of funds to help indebted countries to remain liquid while they reduce government deficits and debt ratios, and thereby regain market access. These provisions of liquidity will come from the EFSF, which will transform into the ESM in 2013, and potentially from the ECB.

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Given that fiscal union will play such a central role in this bargain, it is surprising that its exact contents have received such little examination, at least in the financial markets. What might it include, and to what extent is it desirable?
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It is now almost universally recognised that the design of the eurozone was flawed, because it did not include a working procedure for fiscal union to underpin the monetary union. However, different sides of the economic debate mean very different things when they say this.
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On the “softside of the debate, it is suggested that there was no mechanism in the treaties for fiscal transfers between the strong and the weak members of the euro, so the latter would receive no compensation for the disappearance of their ability to remain competitive by devaluing their currencies, or for their inability to cut interest rates during recessions. Lately, the “softside of the debate has added a new argument, which is that the ECB should assume a “lender of last resortrole in government debt markets, thus preventing self-fulfilling runs on sovereign debt. As a broad generality, France tends to take this line.
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On the “hardside of the debate, championed by Germany, none of these factors are given very much, if any, consideration. Instead, the flaw in the treaties is viewed as the lack of an effective mechanism to ensure fiscal discipline in the member states. The Stability and Growth Pact (SGP) was intended to limit budget deficits to under 3 per cent of GDP, and to reduce debt/GDP ratios to under 60 per cent.
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The treaties contained elaborate procedures to shift countries towards these objectives, but they were enforced only by peer pressure in the Council of Ministers, and they never worked. Therefore the “hardline holds that new mechanisms are needed to ensure that the budget targets are in fact achieved, and that countries are penalised for failing to hit them.
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These two interpretations of fiscal union have very different implications for what should be done next. Ultimately, some idealists who favour the “softline may like to see a fiscal union in which a central eurozone budget would grow in size, with taxation and public spending being conducted largely at the federal level. This is what is done in the US, where the federal budget dominates the budgets of the states, and ensures that there are significant, automatic fiscal transfers from the strong states to the weak. This may be one reason why the US fiscal union has proven so durable.
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However, in the eurozone, any immediate comparison with the US is no more than a pipedream. The EU budget is only 1 per cent of GDP, while the budgets of member states amount to 44 per cent of GDP, so a US-style fiscal union is unrealistic. Instead, the “softline favours the creation of a eurozone transfer union, in which there are flows of resources from the strong national economies to the weak, either through enlarged fiscal mechanisms (ie the EFSF/ESM, or eurobonds) or through the balance sheet of the ECB.
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The hard-liners take a completely different view. They see fiscal union as involving a binding agreement between all members to run national budgetary policy so that no inter-country flows would ever be necessary. If this binding agreement fails, then the hard line says that countries should be allowed to default on their debt, with the private sector taking their fair share of losses from such defaults.
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Which side of this debate will emerge triumphant from this week’s talks? It seems overwhelmingly likely that it will be the hard line, championed by Germany. Discussions are already very far advanced in this direction.

According to a recent publication from the Commission, the new fiscal union will involve four departures from the SGP which it will replace:
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First, countries will be subject to new limits, not only on their budget deficits, but also on the ratio of public spending/GDP, designed to ensure that spending is forced downwards if debt and deficit ratios are above targets.
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Second, there will be a new procedure which will force countries progressively to reduce their debt/GDP ratios so that all of them will reach no more than 60per cent of GDP over the next 20 years. (German finance minister Wolfgang Schäuble proposed one example of exactly this procedure this weekend.)
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Third, there would be financial sanctions, such as compulsory interest free deposits, or outright fines, amounting to 0.2-0.5 per cent of GDP for countries which are in breach of the procedure.
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Fourth, member states would be expected to adopt a common set of practices into their national budgetary frameworks, so that the targets which had been agreed at a eurozone-level would be enshrined in their own domestic fiscal rules. These rules might includebalanced budget amendments in national constitutions or legislation.
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It seems that only the details of this plan are left to be agreed. The details will matter, including (importantly) whether sanctions will be imposed automatically or by Council decision, and whether countries will be given greater leeway to miss their fiscal targets during recessions. I hope to write more on these details in future blogs.
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But it is already perfectly clear that the German hard line has won the overall debate. And that means that the eurozone is about to lock itself into a fiscal regime which will increase the likelihood of medium term budgetary tightening, come economic hell or high water.