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At a lunchtime meeting on 29 June, Willem Buiter presented results of recent research on the criteria for fiscal convergence written into the Maastricht Treaty. Buiter is Professor of Economics at Yale University and a Research Fellow in CEPR's International Macroeconomics programme. His remarks were based on his CEPR Discussion Paper No. 668, `Should We Worry About the Fiscal Numerology of Maastricht?'. The research presented in the paper was conducted as part of a CEPR research programme on Financial and Monetary Integration in Europe, supported by a grant from the Commission of the European Communities under its SPES programme. The views expressed by Professor Buiter were his own, however, not those of the Commission of the European Communities nor of CEPR, which takes no institutional policy positions.Buiter noted that the proposals for economic and monetary union envisaged in the Maastricht Treaty may be dead and moribund after the Danish referendum. The Treaty requires member states to satisfy two fiscal convergence criteria to become full members of EMU: to keep general government net borrowing and nominal gross debt below 3% and 60% of GDP respectively. Buiter listed several objections to these criteria. At least three countries Greece, Italy and Belgium stand no chance of fulfilling them in the foreseeable future, and achieving them by the target dates would be painful even for `mild sinners' such as the Netherlands. Provisions in the surrounding text that allow membership to EC member states whose governments are making progress towards these norms merely confuse the issue. Also, the permitted levels of debt and deficit are arbitrary and lacking in either theoretical or practical foundation. The average debt/GDP ratio of EC member countries has been close to 60% for every year since 1985, but the 3% norm for the deficit/GDP ratio is well below average; and there is in any case no reason to attach any normative significance to actual (average) past behaviour. Setting the debt criterion in terms of gross rather than net debt takes a very narrow view of the government balance sheet, by forbidding governments to take account of even their most liquid assets in setting fiscal policy. Imposing the proposed asymmetric norms will also introduce an unnecessary contractionary bias: this is reinforced by the need for the automatic stabilizers to operate around an average deficit of less than 3% of GDP, if the norm is only to be exceeded `under exceptional circumstances'. The Treaty makes no provision for a compensating expansionary monetary policy, since it includes no discussion of monetary policy at the Community level. Buiter noted that the proposed fiscal norms are consistent with 5% annual steady-state nominal growth for the Community as a whole, but he argued that individual member countries should adopt different fiscal norms to reflect their different potential for sustainable growth and divergent inflation rates, which should not be ruled out through the imposition of unnecessary uniformity. The Treaty shows a profound lack of understanding of when it is safe for governments to borrow: it provides no justification for ruling out consumption loans, and it only permits borrowing for investment that will fully compensate the government budget for the additional interest payments incurred. It therefore takes no account of governments' well-known inability to appropriate cash returns equal to the social returns to much public investment. Buiter disputed the view that a common currency and high capital mobility induce interest rate externalities. Member states' borrowing exerts externalities regardless of the exchange rate regime, and these are properly reflected in financial markets. A debt bail-out of a fiscally irresponsible government by other member states will be no more likely under a common currency than with separate national currencies. Nor are the proposed ceilings on debts and deficits required to prevent governments that lack fiscal discipline from threatening to default in order to `force' the new European Central Bank (ECB) to monetize their budget deficits. Any such default would damage the holders of the government's debt for the most part its own citizens and banks. The ECB will therefore be able to act as lender of last resort and stabilize the payments system without a bail- out, since it will be in a much stronger bargaining position vis-à-vis the fiscal authorities of any member state than even the strongest and most independent national central bank (the Bundesbank) is vis-à-vis its own Finance Ministry today. Buiter concluded that many member states will have to enforce severe contractions to public expenditure if they are to achieve the Maastricht fiscal convergence criteria; if Germany insists that these be fulfilled as a condition of entry to a monetary union, other member states may therefore do better to remain outside. The benefits of a single currency are relatively small, and quite separate from those expected from the single market, but its costs are far from negligible. Small countries entering a currency union lose the ability to implement an optimal inflation policy, which amounts to relatively little; but larger countries with independent national currencies France, Italy and the UK can achieve changes in relative international prices at lower cost and stand to lose considerable flexibility by joining such a union. |