Trichet’s Original Idea to Protect the Eurozone

The difficulties of one member country could lead to the break up of the Eurozone.  Before leaving the European Central Bank, Jean-Claude Trichet, suggested a fix to this problem by giving to the European authorities supranational powers to impose measures on problem countries.  In other words, Trichet proposed to complement the “no-bail out” clause with a kind of “takeover” mechanism.  This note analyzes this idea and outlines a possible institutional framework to give it a democratic and constitutional foundation.

A few months before stepping down as President of the European Central Bank, Jean-Claude Trichet, gave a speech in Aachen in which he called to reinforce in a decisive way the design of the Eurozone.[i] In this context, Trichet outlined two possible changes of governance:

  • firstly, in the medium term, the adoption of a framework to impose measures on a country that is pursuing policies that trigger major difficulties for other member countries; and
  • secondly, in the long term, the creation of a ministry of finance that would exert responsibilities in the surveillance of fiscal and economic policies, the rules and organizations governing the financial sector, and the external representation of the Eurozone in international financial institutions.

The proposal to complement the single currency and the single central bank with a ministry of finance has attracted a lot of attention in recent months.[ii] On the other hand, the idea of imposing coercive measures on a member country has attracted much less attention.[iii] The goal of this note is to help fill this gap by analysing the rationale for Trichet’s idea and outlining an institutional framework that could help make the proposal politically acceptable.

Rationale for a “takeover” mechanism

In his speech, Trichet was explicit in underlining the reasons why the Eurozone should be protected against a country that threatens the stability of other member countries.  In his view, there is a significant weakness in the present governance of the Eurozone because “all the decisions remain in the hands of the country concerned, even if the recommendations are not applied, and even if this attitude triggers major difficulties for other member countries”. In other words, the instruments that are presently used to impose discipline on member states, i.e. the surveillance of national policies, the recommendations to correct excessive deficits and the sanctions imposed on delinquent countries could turn out to be ineffective in a situation where a member country is not delivering.  The adoption of the euro has enhanced interdependence between member countries to such an extent that a crisis in a single country can indeed menace the financial stability of other countries.  Who would have believed a few years ago that the integrity of the Eurozone would depend so much on the capacity of the Greek and the Italian governments to keep a credible path of adjustment?

The political agreement reached at the European summit in December to enshrine the Golden Rule in national constitutions and make sanctions more automatic, will help correct some weaknesses of the architecture of the monetary union.  Still a situation might arise again in the future where a government’s inability to take adjustment measures could threaten the Eurozone, in the same way as the difficulties of Greece and Italy menace the euro’s survival today.  All the more so that public debt ratios will remain high well above 60 percent of GDP in many countries for many years.  Undoubtedly, this situation will cause tensions among member countries when the demographic shock of ageing will start exerting strong pressure on public expenditure.  This suggests that the flaw in the design of the Eurozone identified by Trichet will remain its Achille’s heel in the future.

Democratic and constitutional safeguards

Trichet proposed to solve this problem by completing the design of the monetary union with a kind of “takeover” mechanism that would allow the European authorities to impose fiscal and economic measures on a national government.  The measures would have be enforceable as law in the country concerned, in a similar way as regulations of the European Union become immediately enforceable in all member states without their having to be transposed into national law.

Reforming the monetary union in this way would represent a “quantum leap” that the opponents of a federal Europe will oppose vigorously.  The question arises, therefore, whether the rules and procedures that would govern this approach could address some of the objections that will be raised by key stakeholders.

Trichet addressed this question by noting that the European authorities that could direct national governments would be “the Council on the basis of a proposal by the Commission, in liaison with the ECB”. This vision needs to be developed further to make it politically acceptable.  Here there are two necessary conditions to be fulfilled.

  • The first is to embed Trichet’s proposal in a firm democratic setting in order to give it political legitimacy and democratic support.  One way this could be done would be to require that the decisions that would be applicable in a member country, be taken by the Council of heads of state and government of the Eurozone by qualified majority, and be endorsed by the Members of the European Parliament representing the population of the Eurozone.  The election of the President of the Council by direct universal suffrage would also strengthen the democratic foundations of the mechanism and give the President greater authority to achieve consensus.
  • The second requirement would be to ensure the constitutionality of the interventions of the Council.  This means that the European Treaties and the national constitutions would need to be reformed to guarantee the supremacy of the legislative acts taken by the Council over national laws.

It would also make sense that the Council’s interventions in the affairs of member countries be limited to exceptional circumstances, i.e. when the financial stability of other countries and the survival of the euro would be threatened.  In this sense, the proposed institutional mechanism would be activated as a last resort, when there is a large consensus within the Council and the European Parliament that no other measures could restore stability in the country concerned and stop contagion.

Political acceptability

One can speculate on the reasons why Trichet proposed to introduce a “takeover” mechanism before completing the Eurozone with a ministry of finance.  A plausible explanation could be the fact that a ministry of finance would represent a much more important step towards political integration than a mechanism to provide a backstop against problem countries.  Indeed, such a mechanism could be established without creating a federal finance ministry with permanent powers.  One does not need to go so far to remove the risk that a crisis in a member country extends to other countries.  This specific problem can indeed be addressed by creating an institutional framework in which the Council would only exert supranational powers in exceptional circumstances, along the lines suggested above.  Such a framework would have no impact on national sovereignty in so far as member countries pursue sound policies.

A number of additional arguments could help make the proposed institutional framework politically acceptable:

  • Creating the possibility of putting a member country under the control of a central European authority would respond to the strong wish of Germany to enforce adjustment measures on transgressing countries and avoid financial transfers.  In addition, an agreement on this approach could convince Germany to support other measures such as the creation of Eurobonds.
  • The strengthening of the role of the heads of state and government would meet the aspiration of France to support deeper European integration via the intergovernmental method.  This approach should be effective because it would be rational for the Council to use supranational powers when the interests of the Eurozone as whole are threatened by one of its members.
  • As the imbalances in the country concerned would often require far reaching fiscal, economic and structural measures and reforms, the Council is better placed than the European Commission to make the necessary political arbitrages so as to ensure the legitimacy of the policy decisions.  In working actively to find a balanced package of measures, the Council would act as the “economic government” of the Eurozone.
  • The prerogatives set for the European Parliament would give democratic credentials to the measures imposed on the problem countries.
  • The role conferred to the European Commission to advise the Council would ensure that the interests and responsibilities of all member countries would always be taken into account.
  • The political penalty attached to the interventions of the Council would contribute to anchor the fiscal and economic behaviour of member states on a sustainable path.  The mechanism would also ensure that no country has the power to secede the Eurozone.  These end results would reassure financial markets and therefore reduce refinancing costs of sovereign debts, thereby lessening pressure on the European Central Bank to fulfil a lender-of-last-resort function.

Conclusion

Strengthening the rules to prevent unsound policies remains a necessary condition for the long term integrity of the Eurozone.  Still, the Greek crisis has shown that the current institutional framework of the Eurozone is unable to protect the Eurozone against a government’s inability or unwillingness to correct excessive budgetary and external imbalances.

The mechanism envisioned by Trichet to fix this problem could be embedded in a democratic and constitutional setting, and have de facto a limited impact on national sovereignty.  This is good news.   Still the implementation of Trichet’s idea would require changes in European Treaties and national constitutions.

Even if it would not be easy to reach a political agreement on these changes, Europe’s political leaders should recognize the relevance of Trichet’s analysis and agree to discuss his proposal.  One way to proceed would be to ask a group of experts in constitutional matters to examine how to reform EU and national laws to transform Trichet’s idea into an appropriate legal system.

References

Goodhart, Charles A.E. and Dirk Schoenmaker (2011), “The political endgame for the euro crisis”, VoxEUorg, 14 December 2011.

Marzinotto, Benedicta, André Sapir and Guntram B. Wolff (2011), “What kind of fiscal union?”,Bruegel Policy Brief, Issue 2011/06, Bruegel, Brussels.

Trichet, Jean-Claude (2011), “Building Europe, building institutions”, speech on receiving the Karlspreis, Aachen, 2 June,

http://www.ecb.int/press/key/date/2011/html/sp110602.en.html.

Wyplosz, Charles (2011), “A finance minister for Europe, VoxEU.org, 11 June 2011.


[i] See Trichet 2011.

[ii] See in particular, Goodhart and Schoenmaker 2011, Marzinotta, Sapir and Wolff 2011.

[iii] See Wyplosz 2011for a first assessment of Trichet’s idea.

2 Responses to "Trichet’s Original Idea to Protect the Eurozone"

  1. georgesdelatour   January 19, 2012 at 3:39 pm

    This article is vile. Unremittingly vile. The author should be ashamed of himself.

    He is talking about imposing sanctions on national electorates if they vote for the "wrong" policies. In Brecht's terms, he wants the government to dissolve the people and elect another.

    He says "such a framework would have no impact on national sovereignty in so far as member countries pursue sound policies". But at every election, each side says the other side's policies are unsound. That's the ground on which political debate occurs. We nonetheless permit people to vote for the apparently unsound party. Because that's what democracy means.