Abstract
With the Euro Area sovereign debt crisis starting in May 2010, the institutional arrangements of the Euro Area were tested in the extreme. Private and public debt levels in a number of member states reached historically high levels. Asymmetric real shocks and the inability to adjust exchange rates in a monetary union have forced unprecedented pressures into the labour market of several member states. Although being far from a uniform process, in some countries public indebtedness has been exacerbated by the financial crisis and recession, and this in turn has contributed to financial instability. In response to this difficult period, as this paper argues, European and national institutions have accepted these challenges and worked collectively towards appropriate policy responses. In particular, the pressing need to undertake fiscal consolidation in many countries and to avoid future fiscal crises in the Euro Area induced a wide array of national and European reform measures.
Holger Fabig and Yannick Kirchhof are with the Ministry of Finance, Berlin, Germany, where Inka Zippe was an intern in September and October 2012. Views expressed in this paper do not necessarily reflect those of the ministry.
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Notes
- 1.
This trend is not confined to the Euro Area.
- 2.
Since 2011, the German Federal Government has been required to reduce its structural net borrowing step by step through the so-called “debt brake,” as enshrined in Germany’s constitution. From 2016 onwards, the Federation’s net borrowing, adjusted for cyclical fluctuations, will not be permitted to exceed 0.35 % of Germany’s gross domestic product. A transitional period, lasting until 2020, has been established for the Länder. From then onwards, they will have to have structurally balanced budgets. A control account has been created, which should be balanced in the medium term. The control account will document non-cyclical deviations from the maximum permissible net borrowing that arise in each fiscal year. To accommodate cyclical fluctuations, additional net borrowing may be incurred during a downturn while in economic good times the resulting cyclical surplus reduces the maximum permissible net borrowing. In an emergency situation, a majority of the Bundestag can approve additional net borrowing. However, this must be accompanied by a binding amortisation plan which provides for the reduction of net borrowing above the standard threshold within an appropriate time frame. This guarantees that higher net borrowing in response to exceptional circumstances does not endanger long-term fiscal sustainability.
- 3.
Under the provisions of the Stability and Growth Pact, EU member states must each year draw up Stability Programmes (in the case of Eurozone members) and Convergence Programmes (for non-Eurozone countries aspiring to join the Eurozone). In these programmes, the member states must provide details of their fiscal policy strategy and report on their compliance with the Stability and Growth Pact.
- 4.
The Excessive Deficit Procedure (EDP) operationalises the procedure that is launched when the budget deficit and public debt exceed the thresholds of 3 % of deficit to GDP and 60 % of debt to GDP, respectively, and ensures that member states adopt appropriate policy responses to correct excessive deficits.
- 5.
A lot of empirical work has dealt with the negative relationship between debt and growth. An often-cited study in this context was published by Reinhart and Rogoff in 2010. Reinhart and Rogoff (2010) found a nonlinear debt–growth relationship, suggesting that GDP growth drops more severely once government debt-to-GDP ratios exceed 90 % (an IMF paper by Kumar and Woo (2010) had similar findings). The existence of a sharp turning point was explained by market perceptions of risk. Most recently, the Reinhart and Rogoff (2010) finding of a debt threshold has been called into question by Herndon et al. (2013) on grounds of identified coding errors and deficiencies in their original data set. In contrast to the finding of a sharp turning point to growth once debt attains a certain level, Herndon et al. (2013) suggest that growth rates merely decline with rising debt, which makes the relationship look rather linear. Beyond the question of linearity, both authors do provide conclusive empirical evidence for a negative association between debt and growth. A look at the literature confirms that firm conclusions on sharp turning points of the growth–debt relationship may be difficult. A more recent IMF publication (IMF World Economic Outlook 2012) found “no particular threshold that consistently precedes sub-par growth performance” but confirms a negative debt–growth relationship.
- 6.
This means that semi-automatic decisions under the reverse qualified majority voting procedure—which previously applied only to the imposition of sanctions in accordance with the reforms to the Stability and Growth Pact—have now been extended to the launching of excessive deficit procedures.
- 7.
The treaty also provides for the organisation of a conference of representatives from the European Parliament and national parliaments to discuss budgetary policies and other issues covered by the fiscal compact.
- 8.
To be further discussed in Sect. 3.
- 9.
Both to be further discussed in Sect. 3.
- 10.
There are additional reasons to be ambitious in fiscal consolidation: Looking ahead, the observable trend of population ageing in many Euro Area countries suggests more serious challenges for public finances in the future. Countries will be ill-prepared to cover these costs unless public finances are consolidated before the estimated period when demographic transition will be most burdensome on the budget. It also entails permanent costs, which would need to be addressed through structural reforms, including a review of pension entitlements.
- 11.
Going for Growth is the OECD’s flagship report on structural policies, where it identifies and reviews progress on key priorities to achieve strong and sustained growth in each OECD country.
- 12.
For the purpose of this paper the periphery includes Greece, Portugal, Spain, Ireland and to a lesser extent Italy, while the core comprises Germany, the Netherlands, Austria and France.
- 13.
Not shown in the diagram below, Spain has been provided with sector-specific financial assistance up to € 100 billion in EFSF/ESM credits in order to stabilise its banking sector (this includes a security buffer, as the exact amount of assistance needed is not known yet). The credit will first be channelled to FROB, the government’s restructuring fund, which will then distribute assistance to troubled banks. As of September 2013, € 41.4 billion have been effectively used.
- 14.
LTRO I and II took place in December 2011 and February 2012, respectively, and accounted for the amount of € 489 billion (net allocation € 200 billion) and € 529 billion (net allocation € 314 billion) respectively. Due to recent early repayments the current volume of longer-term refinancing has been reduced to € 705 billion as of June 28, 2013. Net allocation represents the difference between the LTRO operation and ordinary refinancing operations that expired at the same time and were not replaced by another ordinary refinancing operation in the same amount.
- 15.
The first CBPP which ran until June 2010 had a nominal amount of € 60 billion. As of September 24, 2013, the outstanding amount was € 43 billion. In November 2011, the ECB launched a second purchase program for covered bonds amounting to € 40 billion maturing in October 2012 (CBPP2). The outstanding amount was € 15,7 billion as of September 24, 2013.
References
European Council (2012) Council Conclusions of 28/29 June 2012, EUCO 76/12
Herndon T, Ash M, Pollin R (2013) Does high public debt consistently stifle economic growth? A critique of Reinhart and Rogoff. PERI Working Paper 322
Kumar M, Woo J (2010) Public debt and growth. IMF Working Paper
IMF (2013) Fiscal Monitor of April 2013: Fiscal Adjustment in an Uncertain World
IMF World Economic Outlook (2012) The good, the bad, and the ugly: 100 years of dealing with public debt overhangs (Chapter 3). IMF (October 2012)
Reihnhart C, Rogoff K (2010) Growth in a time of debt. Am Econ Rev 100(2):573–578
Acknowledgements
We are grateful to our colleagues at the Ministry Reinhard Felke, Robert Völter, and Stefan Freitag for useful comments on an earlier version of this paper.
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Fabig, H., Kirchhof, Y., Zippe, I. (2014). Overcoming the Euro Area Crisis—Reforms and Results. In: Callaghan, M., Ghate, C., Pickford, S., Rathinam, F. (eds) Global Cooperation Among G20 Countries. Springer, New Delhi. https://doi.org/10.1007/978-81-322-1659-9_3
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