EU "Moderation" Depends on Compliance with Stricter Rules

Unless countries in the European Union become much more committed to complying with requirements of membership, the “era of great moderation” in interest rates there may come to an end, said Axel Weber, visiting professor of economics.

“There’s nothing wrong with the construction of the euro or the union,” Weber said during a Myron Scholes Global Markets Forum, sponsored by the Initiative on Global Markets, at Gleacher Center in May. “What is wrong is compliance with a set of obligations that you have.”

The recent financial crisis revealed three unsustainable developments among certain countries in the EU, he said:

• Too much public debt, as the result of too much public spending for too many years in a row.
• Unproductive use of capital inflows during growth.
• Reduced global competitiveness due to increased labor costs.

Beginning in the year 2000, the same firm producing the same product paid 25 percent more in accumulated labor costs over 10 years in several EU countries than in Germany, said Weber, former president of the Deutsche Bundesbank and former member of the governing council of the European Central Bank.

“That ability to compete at the global level basically determines your future growth potential,” he said. “Some quarters of Europe read this as Germany is too competitive. The German reading is more that other countries have implemented bad industrial and wage policies so they have priced themselves out of the global market.”

When countries joined the EU between 1995 and 1999, clear rules were established for membership, Weber said:

• Interest rates must be no more than 2 percent in excess of the average of the three best performing economies.
• Deficit and debt must not greatly exceed 3 percent respectively 60 percent of GDP .
• Inflation must be less than 2 percent higher than the three best performing economies.

“What we see now is some reemergence of spreads, probably with an overshooting of markets, but that in itself is not a catastrophic behavior,” he said. “In fact, it’s actually quite normal for financial markets to differentiate in terms of spreads in the ability of governments to pay back.”

EU leaders agree economic governance needs reform in three areas, Weber said:

• Fiscal rules need to be tightened to implement more automatic decisions.
• Macroeconomic imbalances should be addressed earlier and more efficiently with a virtual “tap on the shoulder” of a country drifting into competitive imbalance.
• A permanent stabilization mechanism must be established.

“It is a total illusion to believe that the reform of economic governance might prevent crises in the future,” he said. “These measures alone will not do it. We need a bit more than that.”

EU leaders’ agreement in March on what they called a “comprehensive package” was a step in the right direction, but not enough, Weber said. “Ultimately, the success of the monetary union relies crucially on members’ commitment to comply with a tighter set of rules,” he said. “If loopholes are allowed, compliance is not monitored strictly, and enforcement of compliance is not strenthened, then the new set of rules will simply get us through a few years, but will not do the job of moving us forward on a sustainable basis.”

—Phil Rockrohr