How important is the Reform Treaty for the Euro Area?

The most important changes in last week's Reform Treaty are not the new voting weights, or the EU's High Representative for foreign policy, or the future president of the European Council. Arguably, the most important and least discussed changes relate to the euro area.

 

For the first time, the euro group will be recognised as an official EU institution - and not just as a private dinner club - and it will have the ability to set itself a formal agenda. There are also some subtle changes to the institutional setup of the ECB. These rather subtle areas of economic governance originally appeared in the now defunct constitutional treaty. For a still up-to-date briefing note on the precise implications of the European Constitutions for monetary union, see here. While Angela Merkel's Reform Treaty has left between 90 and 95% of the old Constitution in tact, this is one area in which nothing at all has changed.

 

The Constitution - and now the Reform Treaty - have also facilitated the rules on enhanced co-operation - between members who want integrate beyond the level of the EU-27. Enhanced co-operation was first established in the Amsterdam Treaty, later modified in the Nice Treaty, but never used. Even though the Nice Treaty has lowered the decision threshold to set up an enhanced cooperation project from unanimity to qualified majority voting, the rules were regarded as too cumbersome. The Constitution and the Treaty have made it easier. Now the members of the euro area have no excuse - at least no legal excuse - not to co-ordinate policy further. There is no need to establish any forced parallel structures outside the treaty, as proposed last year by the outgoing Belgian prime minister Guy Verhofstadt. The euro area, for the first time ever, is now in a position to act, totally legally, within the confines of EU law..

 

So now that the framework is in place, what kind of co-ordination are we likely to see? While the co-ordination on budgetary policy seems to be progressing relatively well under the current framework, there is hardly any co-operation on wider issues of economic policy - such as tax policy. When Germany last year raised VAT by 3pp, the French government learnt about it in their newspapers. To prevent such a calamity in the future, enhanced co-operation can be used do set up appropriate structures. Something like a euro area co-ordination council, some administrative unit closely linked to the euro group, might a good start.

 

A bad way forward is the kind of grand-standing proposal we are likely to hear shortly at the next Ecofin council from Nicholas Sarkozy, when he will lay out his vision for economic policy co-ordination. His plans are almost certain to contain two aspects that will prove counter-productive to effective co-ordination. The first is the attempt to get his fingers on the euro area's exchange rate, through the proposal of a adopting a formal political procedure to monitor the euro's exchange rate, and the attempt to allow France to derogate from the commitment by European finance ministers to remove the structural budget deficit by 2010 - which has been the most important achievement of the revised stability and growth pact. For the first time in about 20 years, the Europeans are actually thinking about running a counter-cyclical fiscal policy. If it were not for the French president's amateur understanding of economic issues, they may even succeed.

 

The best outcome would be for Sarkozy to make his loud speech, and then move on to some other subject. This is unlikely to happen. It is very difficult to see how we can avoid any conflict between France and Germany under any foreseeable scenario. The Germans will be horrified when they hear that the French are planning to raise their budget deficit to 5% at a time when Germany heads towards a balanced budget. They will oppose any manipulation of the exchange rate. They may even question the long-term sustainability of a monetary union, in which the members lack a fundamental consensus among the principal goals. We have no indication that Sarkozy is going to back down. Nor do we have any indication that the Germans have suddenly grown a tolerance for French style industrial policy, or higher inflation.

 

This means that the improvements in the institutional and constitutional framework for policy co-ordination come at a time when the political conditions for it are seriously deteriorating. The case for an improved policy co-ordination in the euro area remains strong, but Sarkozy's approach is likely to prove counter-productive. When such a constellation arises in European politics, gridlock is the probably the most benign of all scenarios.

Eurointelligence ECB Watch

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