Can a Euro Treasury End the Crisis?

Michael Stephens | August 14, 2014

Dimitri Papadimitriou introduces Jörg Bibow’s plan for the creation of a Euro Treasury:

It was only a matter of time until the euro area was hit with the kind of crisis from which it is still struggling to recover—this was understood well in advance, by many at the Levy Institute and elsewhere. The problem has always stemmed from a structural weakness in the design of the currency union: member-states gave up control over their own currencies but retained responsibility for fiscal policy. This situation rendered them subject to sovereign debt runs—which occurred when the fallout from a banking crisis fell squarely on euro area national treasuries—of the sort that countries controlling their own currencies do not face.

As we have pointed out previously, member-states are in some ways in the same situation as US states, which are forced to cut back when the economy contracts—that is to say, at the very moment when expanded public spending is required to place a floor under the economic collapse. But US states have the benefit of a treasury at the federal level that can spend without the same sovereign debt concerns (which the US federal government did, briefly, before succumbing in 2010 to a misguided notion of “fiscal responsibility,” not to mention congressional obstruction). The eurozone member-states, however, do not have the benefit of this treasury–central bank combination at the level of the central government—a lacuna Jörg Bibow addresses with the proposal outlined in this policy brief.

One challenge for “United States of Europe” or “complete the union”-type plans is their political toxicity, but Bibow has tailored his Euro Treasury plan so as to minimize the political vulnerabilities (this is not a transfer union) while preserving the principal benefit: ending the divorce between monetary and fiscal powers in the euro area.

Paired with the European Central Bank, the Euro Treasury would fund future public investment spending in the eurozone and issue debt. However, the actual spending would be done by national governments, and (this is key) the size of the grant distributed to a particular member-state would be based on the latter’s share of eurozone GDP. Likewise, the Euro Treasury would collect taxes–which would be used only to cover interest payments on the common debt–in a manner proportionate to member-states’ GDP shares. In other words, this is not a mechanism for regional redistribution (this distinguishes the Euro Treasury from the US Treasury, which ends up redistributing quite substantial sums to the Southern states). Moreover, there would be no discretion involved in Euro Treasury spending. Member-states would agree beforehand on the initial level of spending and its annual growth rate (with a goal of reaching and maintaining a target ratio for Euro Treasury debt–Bibow suggests 60 percent of eurozone GDP).

Despite the rule-based setup, the Euro Treasury would still strengthen countercyclical fiscal policy in the euro area, directly and indirectly. The plan would help provide a fiscal boost in the near-term, since the aggregate level of eurozone public spending would increase. And going forward, the Euro Treasury would enable countercyclical fiscal policy to work more effectively at the national level. Additional grants would be distributed to support member-state budgets in the event of a severe recession (the definition of which would have to be agreed on beforehand). And more broadly, the Euro Treasury would help create more fiscal space for national treasuries. As Bibow explains, it would help make feasible member-states’ adherence to the Stability and Growth Pact (SGP) limits on deficits: grant-supported public investment would not count toward such limits, and debt service would decline as common Euro Treasury debt gradually replaced vulnerable national debt. (Bibow also emphasizes the need for interpreting the SGP’s budget rules in a symmetrical fashion: “if members were allowed to target excessive budget surpluses, this would risk undermining intra-union balance just as much as in the opposite case”).

The goal is to have the Euro Treasury–which, paired with a central bank, would not present the same default risk as national treasuries–issuing the preponderance of public debt (“Within one generation, there would be little national public debt left to worry about”). Without something like Euro Treasury debt, the current strategy is unworkable:

The current regime envisions member-states running (near-)balanced public budgets forever, which would see public debt ratios decline toward (near) zero in the long run. This is a truly impossible endeavor. Not only would it starve the financial system of safe assets, but it would also set up a lopsided regime that shifts all debt onto weaker (private) shoulders, thereby creating perfectly avoidable 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 debt. This void is the key source of its vulnerability and poor performance.

Bibow also makes the case that this creation of a treasury-central bank partnership at the center of the euro area is one of the missing elements in any successful forthcoming banking union. For more on his proposal for a “minimalistic but functional fiscal union,” read the policy brief: “The Euro Treasury Plan” (pdf).

Related: Euroland’s Original Sin“; “What Matters Is What We Do Next

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