The Progressive Economy Scientific Board recognised the added value of the paper in focusing on a specific shortfall of the present EU governance system, namely its lack of a central fiscal institution with the power to spend, tax, and issue debt.
The euro crisis has exposed existential flaws in the euro regime. Intra-area divergences and the corresponding buildup of grave imbalances had remained unchecked prior to the crisis. As those imbalances eventually imploded, member states were found extremely vulnerable to systemic banking problems and abruptly deteriorating public finances. Lacking a (federal) treasury partner, the European Central Bank (ECB) battled to stem area-wide contagion while becoming exposed to legal challenges. Today, most members continue struggling under stagnation, high unemployment, and adverse debt dynamics, while questions remain over the effectiveness of the ECB’s recently launched “quantitative easing” (QE) initiative. Vulnerable to global developments, on which it is unduly reliant as mirrored in a soaring current account surplus, the euro currency union remains stuck in a crisis of its own making, with little hope for a vigorous recovery under its flawed and dysfunctional policy regime.
Investment spending is stuck at a deeply depressed level. Laboring under the Stability and Growth Pact (SGP) and Fiscal Compact, governments across the eurozone have cut public investment spending to an extraordinarily low level. The jointly-undertaken austerity frenzy has proved socially devastating and counterproductive from both a cyclical and long-term growth perspective. Essentially, governments are not only recklessly spoiling the economic fortunes of current generations, but also reneging on the economic possibilities for our grandchildren.
The proposal put forward here features a joint recovery program through an area-wide boost to public investment. In that regard it is not unique (see iAGS 2015, for instance). What is novel about the “Euro Treasury Plan” is the way in which it joins the spending and financing sides of a recovery program that would simultaneously also fill the void in the current euro regime and heal its essential flaw and ultimate source of vulnerability: the decoupling of central bank and treasury institutions.
The euro is lacking a safe footing for as long as the ECB is missing a federal treasury partner – establishing the vital treasury-central bank axis that stands at the center of power in sovereign states (Goodhart 1998). The current regime leaves all players vulnerable. Lacking a central bank partner the national treasuries are subject to default and hence runs. Lacking a Euro Treasury partner and euro treasury debt the ECB is subject to legal challenges of its quasi-fiscal policies as applied to national debts. The Euro Treasury Plan kills two, if not more, birds with one stone, while going a long way towards accommodating some key German reservations as well.
Vehicle for joint funding of public investment
At the heart of the Euro Treasury scheme is a simple and straight-forward idea: to create a Euro Treasury as a vehicle to pool future eurozone public investment spending and have it funded by proper eurozone treasury securities. Member state governments would agree on the initial volume of common area-wide public investment spending and its annual growth rate thereafter. Otherwise the Euro Treasury operates on auto-pilot.
For instance, assume agreement on an initial volume of public investment of 3 percent of GDP, annually increased at a 5 percent rate thereafter. If the implicit Maastricht assumption of five percent nominal GDP growth were to hold, the eurozone would henceforth see steady investment in its common infrastructure while the common Euro Treasury debt stock funding would converge to a steady-state level of 60 percent of GDP by the end of the century. The adjustment would be largely completed within 35 years. Within one generation Europeans would share both a common infrastructure stock and the public debt that has funded it.
This is not simply another “euro bonds” proposal though. There is no debt mutualization of existing national debts involved here, for which member states alone would remain responsible as the no-bail-out clause would stay in place. The Euro Treasury scheme is purely forward-looking, with new common debt funding new public investment as the basis of the region’s – much alluded to but currently grimly neglected – common destiny and future.
The Euro Treasury will not directly undertake the investment spending itself. Instead, it will give investment grants to member state governments exactly in line with members’ GDP shares. The point is that both investment grants and interest payment obligations are calculated based on member states’ GDP shares. Redistribution is thereby excluded by design: The Euro Treasury is specifically designed not to be a transfer union. It is separate from and runs parallel to the EU budget, which remains the sole instrument of any intra-regional redistribution.
The Euro Treasury functions by auto-pilot as there is a strong political case for organizing public investment spending on a strict rule when managed and funded from the center for as long as there is no full-fledged parliamentary democracy in place in the eurozone. Moreover, and in line with the EU’s subsidiarity principle, the Euro Treasury’s power to tax is strictly limited to obtaining revenues to service the interest on the debt and to keeping the debt ratio stable at its target level. On the revenue side of the plan, special tax provisions are designed to generate revenue earmarked for servicing the debt.
Member states must abide by current fiscal rules
Member states will still be required to abide by all the rules of the current euro regime, but applied to current public expenditures only – as national public capital expenditures now form a separate capital budget funded through common euro treasury securities. This makes a vital difference.
The current regime envisions member states running (near-) balanced public budgets forever, which would see public debt ratios decline towards (near) zero in the long run. This is a truly impossible endeavor. Not only would it starve the financial system of safe assets. It also creates financial and economic fragilities. Debt – and in fact growing public debt – is a very natural concomitant phenomenon of economic growth. The euro regime is lacking a central fiscal institution with the power to spend, tax, and issue (safe) debt. This void is the key source of its vulnerability and ill-performance.
Especially following a financial crisis, marked by excessive leverage, the private sector will seek to run a financial surplus. Only when the recovery has turned into a new boom, can we expect the private sector to reach a balanced financial position. Given a structural financial surplus for the private sector over the cycle, the public sector can only realistically balance its own books structurally if the country (or currency union) runs perpetual external surpluses. This amounts to the German model. Replicating the German model for the eurozone as a whole will persistently depress domestic demand and provoke global tensions. The German model is the wrong model for the eurozone (Bibow 2001, 2012).
As to the evolution of national public debts under the Euro Treasury Plan, steady deficit-spending on public investment funded at the center will finally allow and enable national treasuries to (nearly) balance their structural current budgets. Within one generation there will be little national public debt left to worry about. This overall outcome would resemble the situation in another – functioning – currency union: the United States.
Minimalistic fiscal union that safeguards Europe’s infrastructure and common future
The Euro Treasury Plan would create a minimalistic but functional fiscal union that follows the subsidiarity principle and accommodates some key German reservations: the proposal does not constitute a transfer union, requires that the member states abide by the current rules, and foresees that the Euro Treasury operates on a fixed rule rather than discretion. The fixed rule for its operation is known as the “golden rule of public finance”, which was anchored in Germany’s constitution until it was replaced by the “debt brake” in 2009. The latter essentially amounts to a balanced-budget rule, while the former acknowledges that public investment should be debt-financed.
By steadying public investment at an adequate level, the Euro Treasury would provide a basic ingredient for turning the euro into an engine for joint prosperity rather than joint impoverishment. The Euro Treasury epitomizes the fact that both sides of the balance sheet matter: issuance of common Euro Treasury bonds serves to fund the infrastructure upon which Europe’s future will rest. The current austerity crusade denies the conventional wisdom of the “golden rule” and impoverishes Europe. The Euro Treasury turns the golden rule of sound public finances into the anchor of European integration.
Beyond the basics: other benefits and potential functions
The Euro Treasury Plan has more to offer still.
First, the Euro Treasury would empower the national automatic fiscal stabilizers. The experience of macroeconomic performance under the euro regime has revealed insufficient fiscal stabilization capacity. While public investment spending funded by the Euro Treasury will not be counter-cyclical but merely steady, indirectly the Euro Treasury contributes to the public finance function of stabilization in significant ways. Most importantly, by requiring and enabling the decline of national public debt ratios to very low levels in abidance with the rule of balancing structural current budgets at the national level, member states will restore their fiscal space. National automatic stabilizers would thereby regain the necessary breathing room to actually do their job.
Second, it would be easy to augment the strict (“golden”) rule for debt-financing steady public investment spending by allowing the Euro Treasury to do more in a severe downturn. If GDP declines by, say, 2 percent or more, the Euro Treasury could (automatically) extend additional all-purpose grants to member states (based on GDP shares) that support member states’ budgets. This would provide extra breathing room for quasi-automatic stabilization put into effect in a decentralized way. Once recovery is established the tax for servicing Euro Treasury debt could be temporarily raised so as to assure re-convergence to the target debt ratio for euro treasury debt within a certain time period.
Third, as a flexible and reliable emergency funding source, the Euro Treasury is the natural fiscal backstop for the “banking union”, breaking the infamous “bank-sovereign doom-loop” that arises as the two parties are closely intertwined in terms of their liquidity and solvency status. Troubled banks can bring down the sovereign – and vice versa, especially if national treasuries are divorced from their central bank. The solvency backstops currently foreseen in the banking union are insufficient and remain largely national. The European Stability Mechanism (ESM) is too small and unwieldy. Not being in a position to effectively counter systemic events risks calamitous accidents. Coupling the ECB’s quick pockets with the Euro Treasury’s deep pockets would provide a strong bulwark against any threat of financial meltdown. The ECB would henceforth operate in euro treasury debt only but never touch national sovereign debt again. Accompanied by banking regulations that effectively prevent the concentration of national sovereign debt on bank balance sheets, the Euro Treasury will thereby cut through the “doom loop” and make the “no-bailout clause” workable at the same time. Discretion is inevitable in this regard, which is no different from the current situation; only that the Euro Treasury rests on a much sounder funding basis than the ESM and restores the treasury-central bank axis of power at the center.
Fourth, the Euro Treasury would provide the common safe asset that the common market yearns for, serving to establish a common term structure of (risk-free) interest rates. Currently private creditors across the eurozone are facing diverging borrowing costs and credit spreads based on their nationality as private credit risks continue to be priced off their respective national benchmark. This situation starkly conflicts with the whole purpose of both the common market and the common currency. The Euro Treasury plan would overcome this fundamental inconsistency.
Fifth, the Euro Treasury could facilitate mutual insurance. Mutual insurance differs from redistribution policy. The latter features permanent transfers designed to reduce disparities in income levels among member states. In the EU this is mainly handled through the EU budget; a very limited “transfer union”. By contrast, a mutual insurance scheme featuring temporary fiscal transfers may be specifically designed to stabilize – rather than level – incomes. Mutual insurance is called for to counter “asymmetric shocks”, shocks that affect currency union members differently (European Council 2012). The Euro Treasury would serve as the conduit through which member states make or receive temporary fiscal transfers depending on their relative cyclical position vis-à-vis the eurozone average. The required size of the mutual insurance budget could be very small in practice, but still provide significant stabilizing effects (Pisani-Ferry, Italianer and Lescure 1993). An important caveat arises here. Mutual insurance runs into trouble if lasting divergences in competitiveness positions are not prevented – as witnessed prior to the crisis. Such divergences result in a buildup of imbalances that can ultimately give rise to permanent transfers. A currency union may be able to sustain income disparities among members with minimal redistribution policies for quite some time. But failure to maintain balanced competitiveness positions can drive weaker member states into bankruptcy fairly quickly. As a rule, unit-labor cost trends of member states must stay aligned with the currency union’s common price stability norm (i.e. the ECB’s inflation target of “below, but close to, 2 percent”). When German wages stopped growing under the euro, Germany’s partners inevitably lost competitiveness. The eventual implosion of these imbalances is behind the still unresolved euro crisis (Bibow 2006, 2012, Flassbeck 2007). Preventing permanent transfers presupposes preventing persistent divergences in competitiveness positions.
Last, but not least, the Euro Treasury Plan is also a recovery program. A direct stimulus arises from simply normalizing public investment spending, which, due to counterproductive austerity, currently stands at only 2 percent of GDP. A return to a more normal 3 percent of GDP (or temporarily more) would provide a corresponding boost to growth. At the national level fiscal space will be restored through refocusing the fiscal regime toward balancing national structural current budgets and through a declining interest burden. Member states will see their tax contributions to finance the interest burden on the euro treasury debt gradually build up over time as their debt service on national public debt is set to decline simultaneously. Gradually transitioning from servicing high-interest national debt to servicing low-interest common debt will result in significant overall budgetary relief. Ultimately dynamics for the euro treasury debt should be similarly favorable as in the U.S. case. Permanent primary deficits are a realistic prospect. Note also that the (automatic) “Euro Treasury Recovery Program” would foster a more benign rebalancing of intra-area competitiveness positions, namely by providing a broad-based, area-wide stimulus. Currently the rebalancing process inside the euro currency union is very asymmetric: euro crisis countries are forced to undergo “internal devaluation” without any concomitant pressure on creditor countries to expand. Faster domestic demand growth and higher wage-price inflation in creditor countries is vital and would contribute greatly towards a more benign rebalancing and proper recovery of the eurozone as a whole.
Summary: The Euro Treasury makes the euro viable
The euro crisis remains unresolved and the euro currency union incomplete and extraordinarily vulnerable.
The Euro Treasury Plan amounts to a rudimentary fiscal union, not a transfer union though, as benefits and contributions are shared proportionately. The Euro Treasury would allocate investment grants to member states based on their GDP shares. And it would collect taxes to service the interest on the common debt, also exactly in line with member states’ GDP shares. The plan is purely forward-looking. Following the “golden rule of public finance” the Euro Treasury would issue common Euro Treasury debt to jointly fund the infrastructure spending which is the basis for the union’s joint future.
Member states would still be required to abide by all the rules of the existing euro regime, but this would apply to current public expenditures only—as national public capital expenditures would form a separate capital budget funded through common Euro Treasury bonds. The Euro Treasury Plan thereby enables the decline in national public debt ratios to low and safe levels, restoring the fiscal space for automatic stabilizers to operate freely at the national level.
The ECB needs Euro Treasury debt for monetary policy purposes. And the markets need Euro Treasury debt to establish a common benchmark for financial instruments issued by debtors of euro member states, irrespective of nationality. The Euro Treasury would establish the vital treasury–central bank axis of power, healing the euro’s potentially fatal birth defects.
It would also provide the needed stimulus to end the crisis. As a recovery program, the Euro Treasury Plan involves an immediate boost to public investment spending across the Eurozone. The switch to applying the SGP to national current expenditures and the prospective decline in the interest burden will open up further fiscal space. The resulting area-wide fiscal stimulus will allow a more benign (less deflationary) intra-area rebalancing to unfold.
Hopefully improved overall performance under the new euro regime proposed here will lead to more solidarity and forgiveness of blunders of joint responsibility over time. Acknowledging that full-fledged political union may be a long way off and German fears of a “transfer union” difficult to appease, the Euro Treasury Plan more narrowly focuses on what may be feasible in the near term. Arguably, the Euro Treasury Plan would both stimulate a broad-based recovery and prepare the ground for further integration in the future.
Bibow, J. (2001) Making EMU work: some lessons from the 1990s, International Review of Applied Economics 15 (3): 233-259.
Bibow, J. (2006). The euro area drifting apart – Does reform of labor markets deliver competitive stability or competitive divergence?, in Structural Reforms and Macro-Economic Policy, ETUC, 76-86.
Bibow, J. (2012). The Euroland crisis and Germany's euro trilemma, International Review of Applied Economics 27(3): 360-85.
European Council (2012). Towards a Genuine Economic and Monetary Union, December 5.
Flassbeck, H. (2007). Wage divergences in Euroland: Explosive in the making, in: J. Bibow and A. Terzi (eds) Euroland and the World Economy – Global Player or Global Drag?, Palgrave Macmillan.
Goodhart, C.A.E. (1998). The two concepts of money: Implications for the analysis of optimal currency areas, European Journal of Political Economy 14: 407-32.
Pisani-Ferry, J., Italianer, A. and Lescure, R. (1993). Stabilization properties of budgetary systems: A simulation analysis, European Economy 5: 513-538.
Jörg Bibow is Professor of Economics at Skidmore College and Research Associate at the Levy Economics Institute. He holds a PhD from the University of Cambridge since 1996. His research interests are: Monetary Economics, International Finance, Central Banking, Financial Markets, European Integration, Trade and Development and History of Economic Thought.