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A New Fiscal Union for Europe

Author: Christopher Alessi
Updated: December 9, 2011

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Meeting at an EU Council summit in Brussels late into Thursday night, leaders of the seventeen eurozone countries agreed to sign a new intergovernmental treaty (NYT) mandating greater fiscal coordination and budget discipline. The highly anticipated decision is meant to quell months of market volatility by offering a long-term solution to the ongoing eurozone sovereign debt crisis.

The agreement is based on a plan put forward by German Chancellor Angela Merkel and French President Nicolas Sarkozy--outlined in a letter to the EU Council on December 7--broadly calling for automatic sanctions for fiscal misbehavior, a greater role for the European Commission in drafting national budgets, and financial tax harmonization (BBC) across the EU.

Merkel and Sarkozy had pushed for a full overhaul of the existing EU treaty, but were forced to adopt a new agreement when British Prime Minister David Cameron rejected the fiscal union outright after failing to obtain concessions (DeutscheWelle) to protect Britain's financial sector. The new intergovernmental pact is expected to include twenty-three EU countries (WSJ), including six non-eurozone states that hope to join the single currency in the future.

What's at Stake

Credit rating agency Standard and Poor's said on December 5 that it saw a one in two chance of downgrading the debt (Bloomberg) of fifteen eurozone countries over the next month, including Germany and France from their long-held triple-A statuses. The announcement raised borrowing costs throughout the eurozone, including in Germany, which has some of the world's safest government bonds. S&P also put on notice the temporary eurozone bailout mechanism, the European Financial Stability Facility, which relies on the high-rated debt of Germany and France to obtain cheap financing. The move threatened to accelerate sovereign contagion, while igniting fears that the euro was on the brink of collapse.

The Debate

Analysts have expressed skepticism over the long-term efficacy of the Franco-German plan in resolving the debt crisis. A recent Guardian editorial suggests that Merkel and Sarkozy's decision to address austerity and not growth will only buy time, while failing to "tackle the roots of Europe's problems." Similarly, a Financial Times editorial calls for a more "imaginative approach, and one that holds out the hope of rebalancing within the eurozone, not just an endless vista of austerity."

At the same time, many observers see the newly agreed upon fiscal union--and Britain's rejection of it--as a vital political step forward in the preservation of the single currency. The Financial Times' Wolfgang Münchau argues that the split of the eurozone from the larger EU was inevitable and essential. The summit demonstrated that a "monetary union cannot coexist with a group of permanent non-members in a unified legal framework," he writes. For the eurozone to survive, the greater EU must be reconstituted or destroyed, Münchau explains. Indeed, Britain's decision not to take part in the fiscal union is paving the way for a new Europe unhindered by half-hearted British engagement, says Der Spiegel's Roland Nelles. He contends that Europe is "on the path towards becoming a federal country."

Policy Options

Analysts also concede that under the guise of a stronger fiscal union, the European Central Bank would be in a better position to shore-up some of the eurozone's high-yielding bond markets. The Franco-German plan would "provide vital cover for the hitherto reticent ECB to intervene more robustly in support of Italy, Spain, and other states," writes TIME's Leo Cendrowicz.

Moreover, Deutsche Welle's Gregg Benzow explains, "There is widespread pressure on the ECB to douse the fiscal fires by simply printing enough money to buy up large quantities of eurozone debt."

Background Materials

The eurozone, once seen as a crowning achievement in the decades-long path of European integration, is buffeted by a sovereign debt crisis of nations whose membership in the currency union has been poorly policed, explains this CFR Backgrounder.

This New York Times guide provides an overview of the eurozone sovereign debt crisis and an explanation of recent developments.

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