If it seems as though the past week’s events in Europe are unfolding like a well-choreographed dance ahead of a two-day summit starting today, they are.
European Central Bank President Mario Draghi called the tune by hinting on Dec. 1 that he might do more to fight Europe’s sovereign-debt crisis if the euro area agreed to a new fiscal compact. Within days, Italy’s Cabinet, led by Mario Monti, the new technocratic prime minister, proposed painful budget cuts to tame the country’s debt. The next day, the German and French leaders, in a trademark pas de deux, agreed on strict procedures to deal with fiscal sinners that all 17 members of the currency bloc would have to adopt. Yesterday, officials discussed how to beef up a rescue fund that would spring into action in 2012, a year earlier than planned. The ECB took action today by cutting its benchmark interest rate by a quarter point to 1 percent, matching a record low.
By the time the heads of state depart Brussels tomorrow, they hope to have agreement, at least among the currency bloc’s leaders, on measures aimed at convincing baying markets that the debt crisis is finally under control. Their latest plan will probably include a closer fiscal union overseen by a supranational body of technocrats and automatic sanctions for countries that breach the rules -- annual deficits below 3 percent of gross domestic product and total debt below 60 percent of GDP. Draghi, we hope, will cap it all off by making good on his quid pro quo offer with central bank bond purchases or guarantees.
There’s one crucial step they mustn’t overlook: Euro-area countries will need to put treaty changes to parliamentary and popular votes, and that means they’ll have to convince both the rescued and the rescuers that the package is a good deal. To that end, the premiers should go into their meetings with a list of principles for winning over grass-roots support.
Our list begins with a warning that enforcement can’t be overly Teutonic. Instead of adhering to the kind of strict, unbending rules that German Chancellor Angela Merkel seeks, the panel of technocrats should have the discretion to recommend to a sovereign nation spending cuts and tax increases, but not impose them. Its remit could include issuing milestones that are tailored for each country and totally transparent. Italy, for example, might have to hit the 60 percent debt-to-GDP ratio -- from about 120 percent now -- within a set number of years (it could take decades) but reform its labor markets, civil service and public pensions more quickly, say by 2014.
The supranational panel, which would have the right to inspect Italy’s accounts, could also publicly award quarterly or semiannual fiscal grades reflecting how closely Italy is hewing to the budget milestones it negotiated and accepted.
The enforcement rules must also have incentives for fiscal rectitude and disincentives for recklessness. For instance, once the immediate crisis is past, a country could be allowed to issue new debt in the form of euro bonds that are collectively backed by all euro-area governments -- but only if it has at least a “B” fiscal grade.
Alternately, a country that repeatedly misses its fiscal targets could be put in the timeout box by having its voting rights in various European panels suspended temporarily, or its fiscal aid cut.
The package must contain a countercyclical escape valve so that temporary deficits are allowed in bad economic times, as long as they are made up for in good times. Finally, the summiteers should leave the door open for controlled Greek and Portuguese defaults. The two countries might not be able to lower their debt ratios to 60 percent without destroying their economies and demoralizing their citizens.
Any enforcement mechanism that makes voters feel they’ve yielded too much sovereignty to a central authority will be voted down in places like Ireland, Italy and Spain. And if the rules are too loose, the bond market won’t believe the fiscal compact is credible. The last thing the euro area needs is a popular rejection of treaty changes or another debt crisis. It’s imperative that Europe’s leaders strike the right balance.
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