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Weighing a European Fiscal Compact

Author: Christopher Alessi
December 20, 2011

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On December 16, European Council President Herman Von Rompuy circulated a draft of the new EU intergovernmental treaty (PDF) agreed on by European leaders a week earlier. The fiscal compact-- set to be adopted by all seventeen eurozone states--mandates more centralized EU control over national budgets and sanctions for countries that do not meet deficit and debt reduction targets. The draft says the treaty could come into effect after just nine governments ratify it (NYT). At the same time, countries outside the euro--of which all except Britain are expected to sign onto the agreement--would not be required to abide by the treaty until they adopted the single currency.

What's at Stake

The new fiscal agreement is meant to signal to volatile European and global markets that the EU is putting in place measures to stop eurozone sovereign debt contagion from spreading. Higher borrowing costs in Italy, France, and even Germany--the core of the eurozone--have raised fears that the euro could collapse, triggering a new global recession. Market actors have looked for EU political assurances in the wake of gloomy economic data (NYT), including the European Central Bank's stark warning this week that eurozone growth will slow next year, while market financing dries up further for the continent's banks.

The Debate

European leaders and analysts remain divided over the legal implications of the intergovernmental agreement, mainly, whether or not such a move is authorized under the EU's umbrella Lisbon treaty.

The legal departments of the European Commission, the European Central Bank, and the European Council have all voiced doubts (DerSpiegel) over the agreement's construction and whether it can be made binding. But Christian Calliess, a legal expert at Berlin's Free University, told Der Spiegel that while the intergovernmental fiscal agreement may not be the "optimal solution," there are many historical examples of special agreements among some EU states that fall outside the main treaty, including the recent creation of eurozone bailout funds. Still, it remains unclear the extent to which the European Court of Justice and European Commission would have the authority to enforce the new accord, say the Wall Street Journal's Laurence Norman and Matina Stevis.

Policy Options

EU policymakers and analysts are also divided over whether the intergovernmental treaty will address the root causes of the debt crisis in the long term. Kathleen R. McNamara of Georgetown University writes that the eurozone will only reassure markets if it takes bolder political steps (ForeignPolicy.com)--including the issuing of eurozone bonds--and focuses on growth over austerity.

However, the New Yorker's John Cassidy says the fiscal compact creates an "institutional framework" for resolving the crisis, and the "outlines of a long-term solution." But he admits that markets will only be reassured in the short term if the ECB plays a greater role in shoring up the high-yielding bond markets of indebted eurozone states--a role that ECB President Mario Draghi (FT) has hinted the bank may be willing to play. With European leaders unlikely to implement the intergovernmental treaty until at least March, pressure on the ECB is likely only to intensify.

Background Materials

An agreement by EU leaders to create a new fiscal union signals a political commitment to the euro but will not immediately solve the eurozone sovereign debt crisis, says economist Iain Begg.

Britain's decision to opt out of the plan could dramatically reshape the path of European integration, says this CFR Analysis Brief.

Membership in the eurozone currency union has been poorly policed, threatening what was once seen as a crowning achievement in the decades-long path of European integration, explains this CFR Backgrounder.

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