Europe urged to adopt stability pact ‘with teeth’

14/05/2010 |

Europe must enact a tough new system of budget control that will ensure governments that rack up excessive deficits suffer harsh penalties, leading policymakers and economists have said

Europe must enact a tough new system of budget control that will ensure governments that rack up excessive deficits suffer harsh penalties, leading policymakers and economists said today.

The warning comes as a tug-of-war between national sovereignty and the push for fiscal co-ordination in the eurozone threatens to trigger a sovereign debt crisis.

Vito Tanzi, a former Italian deputy finance minister and head of fiscal affairs at the IMF, said the European Commission had to do a “much better job” of scrutinizing members states’ budget policies.

“If we have come to the stage where a small country like Greece can put the entire global financial system at risk, we really have to rethink the system,” he told Emerging Markets.

“Deeper political union is no guarantee. The only way to ensure that this works is through rules with penalties attached to them. We need penalties backed by formal laws in each country.”

Charles Wyplosz, an acknowledged expert on the euro, agreed that collective fiscal discipline overseen by the stability and growth pact had failed.

Wyplosz, an economics professor at the Graduate Institute in Geneva urged member states to adopt national rules based on the fiscal rule Germany enshrined in its constitution last year.

“They must make it tougher and have the sorts of punishment that work,” he said. “They have threatened [in the past] but at the end of the day a government does what it need to do to be re-elected. That is what will happen in Greece later this year - and in Portugal and Spain.”

Carlo Cottarelli, the current director of the fiscal affairs department at the IMF, told Emerging Markets Western countries urgently needed to enact laws which punished governments that flouted fiscal rules.

“Clearly, advanced economies need to construct a mechanism for enforcement of fiscal rules in addition to strengthening their public finances,” he said.

Cottarelli said: “Penalties are needed and the best benefit of this is the political loss that comes with breaching these rules or targets.”

On Thursday, the European Commission called for a centralized review of government budgets, in a baby step toward greater co-ordination in fiscal affairs.

Barry Eichengreen, an economics professor at the University of California, said Europe needed a stability pact “with teeth”.

“[It needs] a pact where there are stricter limits on deficits, not a focus on arbitrary limits but where the Commission intelligently looks at debt sustainability,” he said.

“And we need a proper enforcement mechanism with penalties. If the commission can’t do it, then there should be an external fiscal council to do it.”

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