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Contribution to the Roundtable Discussion on ‘Strengthening Economic Governance’ at the Conference on ‘EMU and Economic Governance’ organised by DG ECFIN and GOPA

Speech by Otmar Issing, Member of the Executive Board of the ECB
Brussels, 28 September 2004

1. Introduction

The formation of Economic and Monetary Union (EMU) has created a framework for economic policy-making in Europe which is unique in history. While the single monetary policy is oriented towards a union-wide objective, namely the maintenance of price stability, the other policy areas – involving fiscal and wage policies – largely remain the competence of national governments and other national actors, such as the social partners.

The combination of a centralised monetary policy and decentralised other policies has led to the evolution of a new set of rules and objectives for national and supranational policy-makers. The Maastricht Treaty and the secondary legislation, including the Stability and Growth Pact, provide the basis for this new set of rules and objectives and have thereby established a blueprint for a sound system of economic governance in EMU.

In the process of implementing this blueprint, calls for enhanced macroeconomic policy co-ordination have come about as a result of the perception that the new institutional framework in EMU is asymmetric and requires to actively manage the spill-over effects between the different policy areas. In this context, proponents of enhanced co-ordination typically stress that EMU has led to further integration, notably of bond markets, and thus has increased the interdependence of participating countries.

The central message I wish to convey here, however, is that there are no convincing arguments in favour of changing the existing blueprint for economic governance by attempts to co-ordinate macro-economic policies between the main players, i.e. monetary policy, fiscal policy and wage policy ex ante. On the contrary, attempts that extend beyond the informal exchange of views and information give rise to the risk of confusing the specific roles, mandates and responsibilities of the policies in question. Thereby they reduce the transparency of the overall economic policy framework for the general public and tend to prevent the individual policy-makers from being held accountable.

Instead I shall argue that national governments and social partners should design and implement the policies for which they are responsible, taking the current institutional set-up as a point of departure and bearing in mind its basic governance principles. As a result sustainable and prudent fiscal policies and appropriate developments in wages, which take into account the interdependencies between the latter and the stability-oriented single monetary policy, will already go a long way towards strengthening the existing economic policy framework.

Obviously, if national governments and social partners take the single monetary policy’s credible commitment to maintain price stability as given, when deciding upon their own actions, this will lead to implicitly co-ordinated policy actions and, finally, to positive outcomes ex post, while at the same time limiting policy conflicts and overall economic uncertainty. This reflects the basic insight that if the objective and the actions of the single monetary policy are clearly understood and if the other policy actors independently follow appropriate and prudent policies there is no reason to believe that ex ante co-ordination would produce better outcomes.

2. The limited scope for ex ante co-ordination of macroeconomic policies

Typically, calls for policy co-ordination are based on the idea that individual policies, which affect one another, should take one another’s objectives and actions into account. Partial neglect of these interdependencies – so-called externalities or spill-over effects – would lead to a sub-optimal outcome of policies which policy-makers could improve upon through an agreement on a joint setting of their instruments in order to realise possible welfare gains. This idea appears to be an attractive and self-evident proposition. However, a number of lessons can be drawn from both the empirical and theoretical literature which indicate that there are severe conceptual problems, notably the policy-makers’ limited ability to gather and process all relevant information in an effective and timely manner. Such problems clearly limit the scope of ex ante policy co-ordination for the purpose of practical policy-making.

Even more important, the calls for ex ante policy co-ordination generally disregard the political-economy context of practical policy-making and, therefore, an essential component of reality. Policy co-ordination among several policy-makers generally gives rise to the risk of distorting the individual policy-makers’ incentives to choose appropriate policies by confusing their individual responsibilities and reducing their ability to be held accountable. Furthermore, the actual implementation of co-ordinated policy decisions in the jurisdictions of the individual policy-makers may suffer from a lack of appropriate enforcement mechanisms, without which it would be difficult to contain free-riding behaviour by individual policy-makers.

For all these reasons the potential for realising welfare gains from ex-ante policy co-ordination appears to be limited at best, relative to improving a common understanding, providing adequate incentives and establishing appropriate enforcement mechanisms. To the extent that the severe information, incentive and enforcement problems decisively undermine the practicability of policy co-ordination, one may therefore wonder how individual policy-makers can take into account one another’s objectives and actions from the outset so that policy co-ordination would, in fact, be largely unnecessary.

I am convinced that designing the appropriate institutions lies at the heart of the answer to this question. Let me consider the issue of policy co-ordination being conditional on an initial assignment of objectives and instruments to individual policy-makers. Calls for policy co-ordination would, in this case, be based on the assumption that the initial assignment does not appropriately reflect the interdependencies of the policy-makers’ objectives and actions. By contrast, if there is already an efficient initial assignment in place, which does take into account the individual policy-makers’ objectives and actions, and if the policy-makers’ responsibilities are clearly defined, calls for ex ante policy co-ordination would not be necessary. To put it simply, an efficient initial assignment of objectives and instruments, together with a clear division of responsibilities, will achieve implicitly co-ordinated actions and, in the end, positive outcomes ex post.

In the euro area, the Maastricht Treaty and the secondary legislation, including the Stability and Growth Pact, already provide for such an efficient assignment of objectives with a sound and clear allocation of responsibilities to the individual policy-makers thus making the scope for additional policy co-ordination rather limited. This assignment clearly defines the ECB’s role and provides rules for the other policy-makers’ contributions to economic stability.

3. Responsibilities under the “Maastricht assignment”

The central legal basis for economic policy co-ordination within EMU is specified in Article 99 (ex 103) of the Maastricht Treaty, which states that “Member States shall regard their economic policies as a matter of common concern and shall co-ordinate them within the Council.” On the basis of this principle, the framework for the definition of overall economic policy objectives and orientations is provided by the “Broad Economic Policy Guidelines” adopted by the Council each year.

With regard to monetary and fiscal policies, the assignment of responsibilities is defined by the Maastricht Treaty and the Stability and Growth Pact, respectively. The Treaty has assigned the maintenance of price stability as the primary objective to the single monetary policy under Article 105. Without prejudice to its primary objective, the single monetary policy shall support the general economic policies of the European Community. The Stability and Growth Pact provides incentives for maintaining fiscal discipline at the national level by operationalising the excessive deficit procedure of the Treaty. It also specifies a commitment to achieving medium-term budgetary positions “close to balance or in surplus” and incorporates multilateral surveillance procedures and the exchange of information in conjunction with medium-term stability programmes submitted by national governments.

Assigning the overriding objective of price stability to the single monetary policy is a prominent example of how to realise the benefits of the basic division of responsibilities provided for by the Maastricht Treaty. The single monetary policy – safeguarded by an independent central bank – enhances the credibility of monetary policy, increases its transparency and also facilitates its accountability. Similarly, the Stability and Growth Pact provides the right incentives for the conduct of sound and disciplined fiscal policies across all national governments, while preserving sufficient room for manoeuvre for the operation of automatic stabilisers without infringing the ceiling of the deficit-to-GDP ratio.

Of course, safeguarding the soundness and discipline of fiscal policies that largely remain the competence of national governments presents a particular challenge. Ultimately, the sum of twelve national budgets – and, in view of the required fiscal consolidation, their changes – must be brought in line with sustained economic stability for EMU as a whole. As to the necessary control of the national budgets, the Stability and Growth Pact provides for a certain allocation of responsibilities and a balance of power among the Commission and the ECOFIN Council. The Commission is responsible for providing the necessary information and analysis for effective multilateral surveillance, for formulating recommendations for decisions by the Council, and for ensuring the correct application of the Pact. The Council is exclusively responsible for taking decisions and has the ultimate responsibility for enforcing the Pact. These two principles of surveillance and enforcement form the basic idea of the Stability and Growth Pact and must not be put into question.

Having said that and in the light of the discussions regarding the future of the EU fiscal framework, let me re-affirm the Eurosystem’s view that the Stability and Growth Pact is appropriate in its present form, but that there is scope for improving its implementation. Specifically, given that the experience with the Pact since 1999 has been mixed at best, there is a need to provide enhanced incentives to comply with the commitments under the Pact and to increase peer pressures towards enforcing the rules. At the same time, there is a need for increasing the awareness of the basic principles underlying the surveillance and enforcement process. Ultimately, this requires striking a delicate balance between the sovereignty of national governments, the responsibility of the ECOFIN Council for enforcing the Pact and the independence of the Commission, the latter being essential for an effective assessment of national budgetary positions.

While the Maastricht Treaty and the Stability and Growth Pact make provisions for monetary and fiscal policies, wage developments largely remain the result of bargaining among autonomous social partners at the national level. It is evident, however, that the social partners would act in their own interest by ensuring that price stability and a high level of employment are compatible.

If all policy areas concerned respect the aforementioned allocation of objectives and responsibilities and act accordingly, they will already be making the best possible contribution to the Community objectives as provided for by the “Broad Economic Policy Guidelines”.

4. Strengthening Economic Governance by Improving a Common Understanding

An open exchange of views and information between individual policy actors – without any commitment or mandate to take and implement joint decisions – will strengthen economic governance if it manages to improve the common understanding of the objectives and responsibilities of the respective policy areas and does not dilute accountability.

Any form of exchange of views and information, however, should clearly be distinguished from an attempt to co-ordinate macro-economic policies ex ante, which would give rise to the information, incentive and enforcement problems mentioned before. Indeed, given the lack of mutual enforcement mechanisms, ex ante co-ordination among the different policy actors would tend to blur the fundamental responsibilities of the respective policy areas under the Treaty. This, in turn, would distort incentives, reduce the accountability of individual policy actors and ultimately increase uncertainty about the policy framework.

Given the Eurosystem’s monetary policy strategy, there should be no ambiguity how the single monetary policy will respond to developments in fiscal policies and wage settlements to the extent that they will affect the maintenance of price stability. As a result, national governments and wage setters alike should be able to design and implement the policies under their responsibility in a manner that allows for the interdependencies of these policies with the single monetary policy. Obviously, if they take the single monetary policy’s credible commitment to maintain price stability as given, this will help to align expectations and condition their behaviour in a favourable way. National governments and wage setters, in turn, are reassured that monetary policy will respond favourably to appropriate fiscal polices and wage settlements which allow to maintain price stability over the medium term.

All in all, this will lead to implicitly co-ordinated policy actions and, ultimately, to positive outcomes ex post, while at the same time limiting policy conflicts and overall economic uncertainty. This, in turn, will already go a long way towards strengthening the system of economic governance in EMU.


European Central Bank

Directorate General Communications

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