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2017 | OriginalPaper | Chapter

Fiscal Framework Changes in European Monetary Union Before and After Sovereign Debt Crisis

Author : Hale Kırmızıoğlu

Published in: Global Financial Crisis and Its Ramifications on Capital Markets

Publisher: Springer International Publishing

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Abstract

The most important element holding possibility to destroy stability in monetary unions is fiscal policies left under monopoly of countries. There have been debt and public finance policies conducted by member states causing sovereign debt crisis triggered by Global Crunch in Eurozone. Therefore, fiscal framework of European Monetary Union is examined in the study. Fiscal rules adopted by Treaty of Maastricht being the founding charter of European Union and additional measures taken due to hinder experienced are assessed besides theoretical foundations of fiscal policies recommended for Monetary Unions. During analysis of the process, it is remarkable that both such rules and measures taken afterwards have followed each other however, that radical changes have not actually occurred. Only restrictions to national policies have been used instead of common policies in the fiscal field to prevent Eurozone member states to deprive fiscal policies: the only tool, which may be used to handle asymmetrical shocks. However, it is observed that sanctions on the implementation of rules adopted for the fiscal field have always been weak and could, from time to time, easily be broken despite the fact that such rules are qualified as binding.

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previous chapter Public Debt Management in Developed Economies During the Crisis

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For instance, some European countries have followed first examples of supply biased economy strategies of Social Democratic Parties in 1990s. Based on this, they have reduced unproductive expenses, increased public investments and relative tax income acquired from direct taxation. Thus, they have implemented fiscal regulations combining different policies: Netherlands (1990–1994), Greece (1994–1999) and Finland after 1999. Some countries have maintained expense based fiscal regulations: Austria (1995–1997), Ireland (1990–1993/1998–2000), Denmark (1990–1993) etc. (Mulas-Granados 2006).

EMU abbreviation is used for both European Monetary Union and economic and monetary union. This is a natural circumstance, for, widest state of economic and monetary union has come to existence at the monetary union of European Union (El-Agraa 2007).

According to Frankel and Rose (1996), trade volume is high, business cycle and shocks are similar, labour mobility is high amongst optimum currency area members. Also, a fiscal transfer system may exist. For, regions in the space called as optimum currency area and conditions expected to remove possible deviations at such area’s relations with outer world and solution ways are important. Therefore, mechanisms existing to deal with asymmetric shocks are deemed as integral part of optimum currency area.

A common monetary policy implemented for all the countries means ECB to use a single nominal interest rate for Eurozone countries. However, while this circumstance decreases real interest rates in countries holding high inflation such as Greece, Spain and Ireland; it causes real interest to be higher in countries where inflation rates are lower such as Germany. Lower real interest increases domestic inflation by encouraging economic activity. Thus, while Eurozone inflation could be as targeted, the inflation rates of each country will be different (Neck and Sturm 2008; Wickens 2010). Accordingly, money and fiscal policy coordination should be under economic conditions of each country.

ECB has been purchasing Greece, Ireland and Portugal government bonds since May 2010; Spain and Italy government bonds since August 2011. Such bonds have been purchased for 211 billion euros (Gloggnitzer and Lindner 2011; Barth et al. 2011). However, according to Belke (2011) ECB’s such acquisition holding high risk may prejudice the trust towards its political and financial independency.

The criteria of Treaty of Maastricht are five. Criteria regarding inflation rates; inflation rate of a country may not be 1.5 % more than average of three countries with lowest inflation rates. Criteria regarding interest rates; interest rates of long-term government bonds may not be 2 % more than average of three countries with lowest rates. Budget criteria; central government budget deficit may not exceed 3 % of GDP. Debt criteria; government debt/GDP rate should be under 60 %. Exchange rate criteria; national money should fluctuate at 2.25 interval. Also, currency exchange rate mechanism of European Monetary System should remain at narrow fluctuation interval within first 2 years and no devaluation should be imposed on other members within same period.

There are two views on this circumstance. One of them is coronation theory and it is the view, which accepts that only small and relatively homogeneous core countries group should be member at the beginning. Countries reaching required competition power might be accepted to the union by time. In other words, membership to economic and monetary union should be the last crowning step of a real convergence process. The second one is the locomotive theory and advocates that it should be a as comprehensive as possible club. For, the member countries will act by compelling each other on reforms to be made towards a more efficient competition need. In this case, locomotive theory is the one accepted (Cohen 2012).

Germany has been insisting on negotiation regarding SGP in 1995 to strengthen German common sense that Euro may be as powerful and stabile as Mark (Mulas-Granados 2006; Inotai 2011).

European Commission has warned one Eurozone country for the very first time on January 30, 2003. This country is Germany, which is the biggest of European economies and insisting on strict fiscal rules in an ironic manner (Von Hagen 2008; Prokopijevic 2010). Afterwards, the Commission has warned France, Italy, Greece and Portugal. In 2003, sanctions on France and Germany, since they have not observed this clear limit, has been prevented with the voting made; thus, Germany and France has avoided from rules without suffering any penalty. For, it is understood that there would be a set of rules imposed for big countries and another set of rules for small countries (Buti et al. 2008; Inotai 2011; Jovanović 2012).

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Title: Fiscal Framework Changes in European Monetary Union Before and After Sovereign Debt Crisis
Author: Hale Kırmızıoğlu
Publisher: Springer International Publishing
Book: Global Financial Crisis and Its Ramifications on Capital Markets
Print ISBN: 978-3-319-47020-7

Electronic ISBN: 978-3-319-47021-4

Copyright Year: 2017
DOI: https://doi.org/10.1007/978-3-319-47021-4_7