Select Committee on European Union Forty-Second Report

PART 6: Economic Governance of the Euro Area


214. Whilst monetary policy in the euro area has been unified and is now conducted by the ECB, fiscal policy is decentralised and remains under the responsibility of the separate national governments. There is therefore no single natural interlocutor with which the ECB can communicate and co-ordinate its policies; in short, the ECB lacks an equal economic partner for managing the economy of the euro area. President Duisenberg has described the ECB as "the only central bank in the world without a government."[114] It is this asymmetry between institutions and the consequential potential imbalance between policies which causes concern for some commentators.

215. As Professor Buiter explained, in countries with an independent central bank, the ability to coordinate monetary and fiscal policy is never automatic. Consequently, "coordination is hard in a single country like the US or the UK. It is very, very hard if you have 12 national authorities." (QQ 37, 42, 67, 71). Nonetheless, co-ordination between monetary policy and fiscal policy and the different economic policy-making institutions in the euro area is important to ensure that the separate authorities do not enact policies that pull in opposite directions. We raised the question of how to ensure a sensible 'policy mix' in the euro area in our earlier report How is the euro working?[115] At that very early stage of the single currency, however, we could only conclude that the asymmetry between monetary and fiscal policies would "remain an issue". In this section, we re-examine whether the structures in place in the euro area for the exchange of information between the different authorities are sufficient for effective economic governance of the euro area or whether an alternative structure for more active co-ordination of particular policies might be necessary.

Why is there a need for co-ordination between monetary and fiscal policy?

216. Co-ordination of economic policies in the euro area is complicated because there is a single monetary authority (the ECB) but multiple fiscal authorities (the national governments). Although fiscal policy in the EU is controlled at the national level, the EC Treaty is clear that how such policies are managed is nonetheless "a matter of common concern". One of the reasons for this is that, in setting interest rates for the euro area, the ECB has to take account of the fiscal position of the euro area as a whole. Mr Smith argued that as the ECB was not dealing with a single fiscal agent, it was difficult for the ECB to know what fiscal policy the euro area would pursue (Q 22). Professor Goodhart proposed that because of the difficulties that the ECB had in dealing with different national fiscal policies, a logical procedure would be to "move to a more integrationist system" in which more fiscal competencies were given to "the federal centre to accompany the single federal monetary policy" (Q 48).

217. As a consequence of the unified monetary policy in the euro area, it is important that participating Member States' fiscal policies are tightly co-ordinated.[116] The individual fiscal policies of the Member States are therefore subject to the constraints of the Stability and Growth Pact (SGP). The SGP sets out rules for the EU, establishing a framework within which Member States have agreed to co-ordinate their fiscal policies. The Pact is aimed at ensuring the fiscal discipline of the Member States and operates through a comprehensive surveillance procedure, which aims to ensure the fiscal discipline of the Member States through monitoring the national budgets across the EU.

218. The level of government deficits is important for the conduct of monetary policy and affects the ECB and the consequent 'policy mix'. The architects of EMU were concerned that without a co-ordination mechanism such as the SGP, individual EU governments might adopt divergent approaches, which would lead to difficulties for the ECB. The SGP entered into force at the start of Stage Three of EMU (when the ECB started operating and the euro was launched). The restriction on public borrowing imposed by the Pact was intended to ensure that the policy mix in the euro area combined a tight fiscal policy (i.e., budget balances 'close to balance or in surplus' in the medium term) with a less tight monetary policy that would lead to price stability at low interest rates, which would encourage private investment, and thus growth. The Stability and Growth Pact can help Member States to control their debt and deficits, which should provide stability for the ECB.

219. The UK Government said that clear lines of communication between the fiscal and monetary authorities were particularly important in the context of the ECB's independent ability to define price stability. A system of co-ordination where the fiscal authorities understood what the monetary policy reaction would be to a change in fiscal stance would lead to a more predictable policy-making environment. Developing such a situation in the euro area was "a very important area", the Government said (QQ 217-18). Commentators were concerned that the lack of formal co-ordination of economic policies in the euro area could potentially lead to a breakdown of communication and possibly even an abdication of responsibility, where no authority was prepared to take the lead and implement policy changes before one of the other actors changed their policy first. Professor Jean-Paul Fitoussi summarised the potential impasse as follows:

"The monetary policy authorities think that the responsibilities lie with the governments (bad management of fiscal policies of which high budget deficits are a consequences), and the resistance of societies to structural reforms. The governments think that they lie with the central bank (delayed and weak responses to shocks) and also with societies (the difficulty to implement reforms). The average citizen thinks that all actors have a share of responsibilities: fiscal and monetary authorities by not reacting enough, and the private sector by opposing reforms and/or by trying to escape the burden of adjustment to shocks."[117]

220. An example of this type stand off between the ECB and the Member States came in the ECB's announcement in June 2003 that the Governing Council's had decided to reduce interest rates by 0.5% to an historic low of 2%. President Duisenberg argued that the ECB had achieved price stability and he promised to maintain it. He added: "I think that we are credible enough for people to believe that we will deliver what we promise to deliver. And now it is the turn of the governments to do the same thing."[118] This statement was taken by some commentators as a signal that the ECB considered that it had done its part and that responsibility for increasing growth in the euro now lay with the national governments; the ECB would not consider reducing interest rates further until there was a clear sign of commitment to the SPG (through raising taxes and reducing public spending) by those Member States in breach of its rules.[119] A month later in July 2003, announcing that the ECB had decide to hold interest rates at 2%, President Duisenberg again told the Member States that it was time for them to "make their contributions" to boost the economy:

"With medium-term inflation expectations firmly anchored at levels consistent with price stability, and with interest rates at historical lows, monetary policy has made a significant contribution to improving the conditions for a recovery in economic growth. However, other policy-makers also have to assume their responsibilities. Part of the weakness in economic growth in the euro area can be linked to a lack of ambition in the areas of fiscal and structural reform to further improve the conditions for investment and employment."[120]

221. Meanwhile, with Germany still in the position of having an excessive deficit, the German Chancellor, Gerhard Schröder, questioned whether the ECB had "done enough in the context of the dollar/euro exchange rate to maintain the competitiveness of exports from Europe."[121]

The current institutional arrangements for co-ordination

222. There is no formal mechanism for co-ordinating monetary, fiscal and structural policies in the euro area.[122] Indeed, the EC Treaty, which provides the ECB with strong constitutional protection against undue political influence from the outside, explicitly prohibits such co-ordination. A resolution of the Luxembourg European Council emphasised the need for close liaison between the Council and ECB. The resolution stated that "the harmonious economic development of the Community in Stage 3 of EMU will call for continuous and fruitful dialogue between the Council and the ECB, involving the Commission and respecting all aspects of the independence of the ESCB."[123] Policy co-ordination can, of course, take a number of different forms, and there are a number of arrangements in place to enable the ECB and the Member States to co-ordinate with one another.


223. Provision for liaison between the ECB and the Council is made in the EC Treaty, which sets out a number of ways in which the two institutions shall meet. Under Article 113 TEC, the President of Ecofin and a member of the Commission may participate (but not vote) at meetings of the Governing Council of the ECB. In reciprocal fashion, when Ecofin is discussing matters relating to the ESCB, the President of the ECB is invited to participate.

224. Article 114(2) TEC set up an Economic and Financial Committee (EFC) as the main supporting committee for the Ecofin Council. The Member States, the Commission and the ECB can each appoint up to two officials as members of the EFC. The EFC appears to have a vital and wide-ranging liaison function bringing together the knowledge and opinions of the Member States, the Commission and the ECB.

225. The Eurogroup is an informal structure that brings together the Finance Ministers that represent Member States from the euro area; it was designed to promote the exchange of information. The ECB has a standing invitation to meetings of the Eurogroup. The Eurogroup is normally chaired by the Economic Minister whose country is chairing the EU. When the Member State that chairs the EU is not a member of the euro area, however, the representative of the Member State that will hold the next presidency of the EU chairs the Eurogroup and is entitled to attend the meetings of the Governing Council.[124]

226. The Government said, however, that the meetings to facilitate co-ordination between the fiscal and monetary institutions had "not worked very well" in practice. The ECB, for example, had viewed its role "as listening rather than engaging" (Q 219). President Duisenberg denied this and assured the European Parliament that at meetings of the Eurogroup, Ecofin and EFC the representatives of the ECB "urge governments to stand by the Stability and Growth Pact and to exert maximum peer pressure on each other to observe the rules [and] constantly, and sometimes boringly, insist on the necessity for further structural reforms."[125]

227. In spite of this, Mr Trichet acknowledged that there were "disadvantages associated with the current framework."[126] The Government further complained that the representative of the Eurogroup did not always attend the meetings of the Governing Council. Furthermore, when he or she did attend, there was no regular mechanism by which they could report back on what had been discussed at those meetings. The Government supported formalising these arrangements and making it compulsory for the President of the Eurogroup to attend the meetings of the Governing Council (Q 219).

What might happen to necessitate a greater degree of co-ordination between monetary and fiscal policy?


228. Mr Weale considered the lack of formal coordination between monetary and fiscal policy in the euro zone to be a "weakness" in the current EMU set up. His concern was that there no explicit mechanism for the ECB to co-ordinate its interest rate changes with the fiscal plans of the national authorities. He was worried that in such circumstances the euro area could get into a situation, particularly if the SGP was ignored, where the fiscal authorities were pulling in one direction and the monetary authority was pulling in a different direction, and the outcome would be "rather unpleasant." He concluded that some sort of formal co-ordination was "desirable" (QQ 20, 34).


229. Combating deflation would require close co-ordination between the fiscal authority and the monetary authority. Conducting unorthodox policies in the euro area to deal with deflation, such as the monetization of debt, would require delicate co-ordination between the ECB and the 12 Member States, each of which might have different objectives, priorities and operational theories.

230. Professor Buiter said that if deflation happened in the euro area it would be because of an "inability to co-ordinate policy choices". He explained that sustained deflation was "always a policy choice," in the sense that the combined monetary and fiscal authorities could always stop it by creating inflation: "You just run budget deficits and finance them by printing money." One of the difficulties in the EU was that the EC Treaty prevented the ECB from directly financing national governments in the primary debt markets. That did not stop them from monetising the debt, if both the 12 fiscal authorities and the ECB were willing to do so and co-ordinated their activities. "They would simply have the national governments borrowing in the capital markets, and the central bank buying up the debt in the secondary markets." It could be done, but it would require close co-ordination and would be "very, very hard". Professor Buiter did add, however, that the risks of deflation in the euro area were very limited (Q 37). Dr Schmieding also stressed that the euro area was a long way away from the point where any formal co-ordination between fiscal and monetary policies might be needed (Q 67).

Should more be done to ensure the possibility of formal co-ordination of monetary and fiscal policy?

231. The ECB was adamant that it could not accept any formal co-ordination of monetary and fiscal policies. Vice-President Papademos made this position very clear when he stated categorically that there was "no scope for any ex ante co-ordination" of policies.[127] Professor Thygesen counselled that calls for explicit co-ordination should be resisted, because formal co-ordination would weaken the autonomy and independence of the ECB (p.25). President Duisenberg explained, however, that this was not the main reason for the ECB's position, rather the central bank was concerned that any formal co-ordination would jeopardise the bank's ability to deliver its primary mandate of price stability:

"The fact that there can be no question of ex ante co-ordination of monetary and fiscal policies derives not so much from the fact that it would compromise the independence of the Central Bank, but from the fact that it would compromise our dedication to our primary mandate [of price stability]. If we were to co-ordinate, ex ante, our monetary policy with the fiscal policies contemplated by the different governments, we would have to make concessions regarding the pursuit of our primary mandate".[128]

232. Whilst recognizing that some of the arguments for co-ordination of policies were "theoretically rather compelling", Dr Schmieding cautioned against establishing a more formal procedure. The ECB's reticence to enter into any formal mechanism of co-ordination was quite legitimate and was due to the fact that, whilst an independent central bank could look to the medium term, elected national policy makers would continue to be concerned with shorter-term issues. If agreement were reached on the response of fiscal policy if monetary policy were loosened, the ECB might fulfil its side of the bargain and then be let down by the Member States, who could find themselves in a situation where they could not deliver their side of the arrangement. The net result of such a situation would not be positive for the economy. As Dr Schmieding put it:

"politicians find it very, very difficult actually to commit to [an optimal steering of the economy] and to keep their side of the bargain. It is very easy for the Central Bank the next week to act on interest rates. It is much more difficult for fiscal policy to actually push the laws through Parliament. […] Fiscal policy tends to run on its own election dictated cycle with any tightening, if possible, coming after the election and any loosening ahead of the next election. That may or may not by accident meet the requirements of the business side, but it does not lend itself easily to co-ordination with the Central Bank." (Q 71)

233. Dr Schmieding concluded that "for practical purposes" the euro area should maintain the current institutional arrangements and make moves to improve the exchange of information. His advice to the Member States and the ECB was simple: "keep each other informed as much as possible about what fiscal policy may be up to and what monetary policy may be up to; but do not try to rely on any explicit coordination." (Q 71)


234. We heard several such calls for the monetary and fiscal authorities to improve their means and communication and intensify their exchange of information. The question is how this might be achieved.

235. The UK Government called for the reporting arrangements between the ECB, the Commission and the Eurogroup to be strengthened and formalised in the new constitutional Treaty (Q 220).

236. Professor Thygesen suggested that the euro area should move towards "intensified informal co-ordination" of the type practised in the US where there were weekly unrecorded breakfast meetings between the Chairman of the Federal Reserve and the Secretary of the US Treasury. For this to happen in the euro area, the Eurogroup would have to adopt a more permanent leadership than allowed under the present six-monthly rotation of the presidency. If provision for this change could be made in the new constitutional Treaty, it would be "a promising step forward". It would get around the current vacuum that meant that the ECB lacked a body with which it could conduct a regular dialogue about economic policy.[129]


237. EMU has led to the unprecedented combination of a single monetary policy co-existing with separate national fiscal policies. There are those who suggest that some other body is needed as a partner for the ECB. Whether this unique, historical asymmetry can succeed in the long term without further steps towards economic union remains an unanswered question. It is generally accepted that the economic fortune of a nation depends on the monetary, fiscal and structural policies that it pursues. Co-ordination between these three policy elements in the euro area, while theoretically desirable, is difficult to achieve fully in practice, especially between countries in different economic conditions. We have seen no evidence, however, to suggest that a lack of such co-ordination has had any major adverse effects on economic performance in the euro area so far. Evidence provided suggested that other factors, including the unwillingness and dilatoriness of Member States to face up to the need for structural reforms in capital, labour and product markets in their own economies, have been more important in this regard.

238. As of yet, there has not been a great need for co-ordination of monetary and fiscal policies in the EU to go beyond the exchange of information. We note that there is some concern that economic circumstances might change to the extent that more active and explicit co-ordination of particular policies could become necessary at some point in the future. In such circumstances, it is hard to know at present how the EU would respond.

239. There is a case for strengthening the arrangements for communication between the ECB and the Eurogroup. We do not think that this would jeopardise the ECB's independence, which should be rigorously observed and maintained. If the Treaty formalised the Eurogroup and enabled it to operate under a more permanent leadership than presently allowed under the six-monthly rotation of the presidency, it would provide the ECB with a more stable and coherent interlocutor, which could facilitate their dialogue and the exchange of information between them. It could thus strengthen the capacity of the ECB to perform its own functions effectively. Such a change would not alter the powers of the Eurogroup, which would remain a body that could not take any formal decisions on policy.

114   Monetary Dialogue with the Economic and Monetary Affairs Committee of the European Parliament, Brussels, 12 June 2003. Back

115   The report (Eighteenth Report, Session 1999-2000, HL 124) was debated in the House on 5 February 2001. Back

116   On the reasons why co-ordination of fiscal policies through a tool such as the Stability and Growth Pact is necessary in the euro area, see paragraphs 26-49 of our report The Stability and Growth Pact (Session 2002-03, 13th report, HL 72). The report was debated in the House on 4 June 2003. Back

117   'The ECB's monetary policy strategy and structural reforms', Briefing paper for the Economic and Monetary Affairs Committee of the European Parliament, 30 May 2003. Back

118   ECB Press Conference, Frankfurt, 5 June 2003. Back

119   See, for example, 'Can Aggregated Demand In The Euro Area Be Boosted?', Briefing Paper submitted to the Economic and Monetary Affairs Committee of the European Parliament for the Third Quarter 2003 by Professor Guillermo de la Dehesa, p.3. Back

120   ECB Press Conference, Frankfurt, 10 July 2003 and the 'Editorial', ECB Monthly Bulletin, July 2003, p.6. Back

121   'Schröder urges ECB action on euro', Andrew Gowers, Tony Major and Hugh Williamson, Financial Times, 11 July 2003. Back

122   Economic governance must include structural policies, as these can ease the constraints on short-term macroeconomic policies, leading to lower structural budget deficits and enlarging the scope for monetary easing. Back

123   OJ C 35, 2.2.1998, p. 3. Back

124   For example, when Denmark, which has not adopted the euro, held the EU Presidency in the second half of 2002, it fell to the Minister of Finance of Greece, which held the EU Presidency during the first half of 2003, to chair the Eurogroup for a year, starting on 1 July 2002. Back

125   Monetary Dialogue with the Economic and Monetary Affairs Committee of the European Parliament, Brussels, 12 June 2003. Back

126   Hearing on the appointment of the Economic and Monetary Affairs Committee of the European Parliament on the appointment of Mr. Jean-Claude Trichet as president of the European Central Bank, Brussels, 11 September 2003. Back

127   ECB Press Conference, Frankfurt, 4 September 2003. (cf. 'Monetary and fiscal policy in the euro area', Introduction by President Duisenberg at the International Monetary Conference, Berlin, 3 June 2003.) Back

128   Monetary Dialogue with the Economic and Monetary Affairs Committee of the European Parliament, Brussels, 10 September 2003. Back

129   'Macroeconomic Policies and the Case for Policy Coordination in the Euro Area', Briefing paper for the Economic and Monetary Affairs Committee of the European Parliament, by Professor Thygesen, Fourth quarter, 2001. Back

previous page contents next page

House of Lords home page Parliament home page House of Commons home page search page enquiries index

© Parliamentary copyright 2003