Lars Heikensten: Stability and Growth Pact needs reinforcement
Speech by Mr Lars Heikensten, Governor of the Sveriges Riksbank, at a conference organised by the
European Commission, Brussels, 15 December 2004.
* * *
Thank you, Mr Chairman.
I very much appreciate this opportunity to comment on the work of the Commission. Perhaps the
invitation is particularly pleasing for me as, unlike the other members on the panel, I do not come from
a country that has introduced the euro.
I should also immediately say that I very much enjoyed reading the background report and the
communication on the Stability and Growth Pact produced by the Commission.
Let me begin by characterizing the experiences from the Monetary Union so far. There is no doubt that
the regulations on fiscal policy laid down in Maastricht had clearly positive effects up until the euro was
launched. They are still having the same impact on those countries that remain outside the single
currency and have the ambition of joining in the future. Far-reaching measures were taken, and are
also being taken today, to enable entry into the Monetary Union. Noting the progress, some people
have even claimed that earlier less well-functioning national economic-political cultures have been
replaced by a more stability-oriented common European culture. But since the start of Monetary
Union, this momentum has been lost. Several countries have returned to their old behaviour even
though there are good examples of the contrary. And this is not primarily the result of an unusually
long slowdown, as many have claimed. The preceding boom was also unusually long. Furthermore,
we knew that there were large risks associated with the fiscal policies conducted in the initial years of
the Monetary Union. The discussions on fiscal policy were occasionally rather acrimonious in the EFC,
for example. Several of us gave clear warnings regarding the fiscal policies pursued by, for instance,
France and Germany at the time. The Stability and Growth Pact obviously did not serve as the
deterrent it was supposed to be, at least not sufficiently. Nor did EMU - so far anyway - contribute as
much as we had hoped to making the European economy more efficient. Perhaps there are a few
exceptions here related to the financial sector and the financial markets.
It is my intention in this introductory remark to focus on some suggestions for the future. In doing this, I
will talk about macroeconomic issues, rather than dealing with the severe structural challenges Europe
is confronted with. However, before doing this let me make a general comment.
In the present debate some conclude that the current policy framework should be relaxed, which is
normally expressed as saying it should become more flexible. I have difficulty understanding this view.
On the contrary, I think the developments in recent years have strengthened the arguments in favour
of a regulatory framework. From the start there were concerns about "free riders". These concerns
were confirmed sooner than expected. There was also some unease that small countries could be
affected if the larger ones did not maintain discipline. Here, too, developments have given cause for
concern, at least as regards the implementation of the regulations. Allow me to add a third argument.
During the decades before the start of Monetary Union, economic policy in the EU was dominated by
Germany. This was because of Germany's size, of course, but it was also due to Germany's economic
success over several decades and its stable economic policies. There was almost a moral dimension
to Germany's actions. I still remember the meeting in the Monetary Committee when it became clear
that Germany's public finances in the coming years would be as weak as Italy's. The dynamics in the
room changed as if by magic. Since then no country has been able to take over the leader's mantle. In
such a situation peer pressure can easily turn into peer protection.
Let me now turn to the future. In doing so I have tried to be constructive and limited myself to
proposals I believe to be politically feasible. I will be happy to return to any of the subjects I will bring
up.
I. My first point concerns the division of labour and the cooperation between fiscal and
monetary authorities. This is firmly established in the Treaty. The only uncertainty relates to the
responsibility for exchange rate policy. Of course all parties must respect the existing rules. The
demands that fiscal authorities can impose on the ECB are that the bank conducts a clear, consistent
monetary policy aiming at price stability for the Union as a whole, which can be understood and
predicted. In the same way the authorities responsible for monetary policy should be able to count on
a clear, predictable and long-term fiscal policy targeted at achieving balance over the economic cycle
(after taking account of the demographic changes that now lie ahead). More generally, I think that we
in Europe should model our approach on cooperation between the monetary and fiscal authorities
along the lines of the relationship between the Fed and the Treasury during the Clinton years. Europe
would also be better off if the finance ministers followed the advice of my British colleague at a recent
meeting "ask not what the ECB can do for you, but what you can do for the ECB". There may also be a
need for more collegial leadership from the euro area's finance ministers, particularly if rapid
coordinated action is required, something that can not be ruled out. One example could be a situation
with a dramatic and substantial change in the exchange rate, another a financial crisis. A strong
Eurogroup with a respected chairman should be positive in this regard and should facilitate an effective
dialogue with the ECB.
II. Allow me now to comment on the Stability and Growth Pact itself.
It is not difficult of course to see economic arguments in favour of amending the Pact. However, one
fundamental problem is that it is difficult to see how a relaxation of rules in certain areas could be
compensated by a purposeful tightening in others. Relaxing the 3 per cent rule would thereby imply a
weakening of the construction as a whole at a time when - as I mentioned earlier - the conduct in
some countries suggests that if anything the opposite appears to be required. There is already
flexibility in the regulatory framework for different interpretations of the phrase "exceptional
circumstances". To increase this flexibility by allowing for country-specific factors on a general level
would lead to risks. In particular, there is a risk that the rules would be interpreted too much ex post
and that small countries would be discriminated against even more than is already the case.
However, there is room for substantial improvements in the preventive arm of the Pact. The Achilles'
heel of the Pact is not actually the 3 per cent limit but its asymmetry; the pact involves gentle warnings
in booms but hard sanctions in slowdowns. This means that the pact lacks credibility when, after
impotently highlighting indiscipline during booms, it is expected to force governments into highly
painful, 180-degree turns towards austerity during slowdowns. It also risks contributing to procyclical
policy.
Against this background the Commission has worked hard on improving the preventive arm in recent
years. I have sympathy for many of their proposals. Some examples:
• Strengthen incentives in good times. Here, considering the debt level could play a role.
• Timetables could be improved - linking them more closely to national processes.
•
Using the now more developed measures of cyclical balances could also be useful in this
context.
In general, I think it is important to enable the Commission to dig deeper into these areas and to
increase the comparability between different countries. On the basis of this work the Commission's
role should be strengthened as regards giving "early warnings" and proposing measures. I also believe
that the Commission should have the task of emphasising its analyses and going public more than it
does today, thereby being more effective in the general debate in the individual member states.
III. My third point has to do with consolidating the fiscal institutions and regulations at national
level. Here a lot more can be done.
One aspect that too often seems to be forgotten in the debate on the pact is that a balanced,
countercyclical fiscal policy is not just a common European interest; it is in the individual interest of
each country. Some politicians contribute to this misunderstanding when they depict the commonly
adopted criteria as an unreasonable burden from "accountants in Brussels". One manifestation of the
same attitude is the recurring problems with the data that are sent to the Commission. Instead of
having a transparent process, increasingly unrealistic figures are being delivered. There are several
examples of governments reporting data before an election that after the election proved to be
misleading.
The best, and perhaps the only, antidote to these problems is institutionalised transparency; promoting
a regular, public debate on sustainable government finances at the national level. This was the
Riksbank's approach ahead of Sweden's referendum on the euro. We recommended in this context a
model that drew on the experience we have gained from conducting a monetary policy with definite,
clear targets, consistent openness regarding background material such as forecasts and regular and
open assessments and debates.
Key steps in this regard could be taken by any country that wants to do so. But increased support
could also be provided by way of common decisions at European level. Technically, the Excessive
Deficit Protocol already contains an explicit commitment to create national institutions with a view to
developing a fiscal policy framework. The EU leaders can now realise this commitment.
We can also learn from each other in this process. The Commission was quick to perform
benchmarking of budget systems in different countries back in the early 1990s. This was of use to
Sweden when we reformed our budget process after the crisis in the early 1990s. The Commission
could start up this work again. Countries could be studied, compared and put under the spotlight if
they have poor fiscal policy institutions. In this way the national debates could be influenced.
Allow me now to conclude with one general reflection in relation to my introductory comments.
Many of us had hoped that the EMU project would be able to contribute to a faster change of our
economies in a growth-oriented direction. In some countries there has also been less focus on
shortterm stabilisation policy issues - if interest rates are 25 basis points up or down - which are not
significant in the long run for economic performance, and more on long-term questions that are crucial
to growth and prosperity. Comments from the Commission and the ECOFIN council have also had the
desired effect in a number of countries. Policies have been put on the right course.
But the exact opposite tendency exists in other countries. The problems are being shifted on to
monetary policy, which is being conducted at such a distance that the decision-makers can be blamed
without repercussions. Politicians have also tried to take advantage of the situation domestically by
making it appear that they are not bowing to Brussels.
The crucial issue for EMU in the period ahead is which of the two approaches will gain the upper hand.
If the first approach prevails it will go well. But if the second approach dominates the opposite will be
the case. So the trick is to find a system for governance that pulls in the first direction; that focuses
both national and European debates and policies on the real issues.
Thank you.