Saturday, 10 December 2011

Draghi is now the king of Europe

The EU summit just ended took important decisions aimed to restore confidence of the financial markets in the Eurozone. But it is doubtful whether they go far enough to restore the degree of confidence needed so that Eurozone countries can roll over some 250 billion Euro of debts maturing in the firrst quarter (Q1) of 2012. To manage the instability that such financing may cause, the smoothening intervention of the ECB will be crucial.

Mario Draghi -King of Euro(pe)

On Thursday the ECB took decisions that in their immediate impact are more effective than the council decisions taken on Friday. Lowering interests to a record 1% and extending cheap unlimited credit for up to 3 years to Eurozone banks suffering liquidity stress, provide effective measures to avoid a banking crisis as banks restore their capital following losses suffered from the Greek debt write-down.

There seems to be a silent pact between the ECB and the EU council, or may be between Draghi and Merkozy. Provided the EU tightens fiscal discipline on structural deficits the ECB will loosen monetary policy to keep the economy afloat in the restructuring process.

Also the fact that the ECB continues to resist aggressive bond buying of sovereign debt means
that the countries in distress cannot and should not rely on easy ECB funding which could
soften their resolve to stick to their austerity reform program. The ECB can point to
Berlusconi to expose the consequences for those who don't deliver on their promises.

So Draghi is for the next few months or probably for most of 2012 the king of Europe. He has
the power,through the ECB council, to save or sink countries with massive borrowing programs.

Those who ease off their reforms will be punished through high yields on their debt as the ECB
sits on it's hands. Those who persist and deliver will be rewarded by lower yields through
ECB intervention and market confidence.

As to the decisions by the EU Council the broad agreements announced so far do not constitute
a common fiscal policy but more effective fiscal discipline about which Malta should be in

Fiscal union would involve harmonised tax rates and spending limits which would detract
sovereignty and which Malta should resist. The devil will be in the details so it would be
wise for government and opposition to consult widely to adopt a common front in the national

What is disappointingly missing from the agreements is any commitment from the strong core EU
countries like Germany that can borrow long-term funds at absurdly low rates on the markets,
to compensate the fiscal tightening of the countries in distress by fiscal loosening on
their side. There can be no economic growth if all adopt fiscal tightening and without
economic growth there is just no future.

Germany should do more than try to make all the the others look like Germany! They can do
with a Mediterranean dimension themselves. Meeting half way is always less painful!


  1. Can you please explain the difference between fiscal union and fiscal harmonization?

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  3. Fiscal harmonisation is a looser arrangement of a tight fiscal union.

    In a fiscal union countries would have common minimum tax rates ( as is presently the case with VAT rates) and tightly controlled tax break rules and well as more conformity with indirect taxes - e.g. the opt out to have food and medicine at 0% could not remain possible.

    In fiscal harmonisation the tax rates must resemble each other but need not be tightly alike and some concessions may still be possible.

    In both cases fiscal union and fiscal harmonisation would take away one of the main advantages of small countries i.e. the application of a low tax rate to capture business from the bigger audience of the single market. Large countries like Germany and France cannot do so as they would lose substantial tax revenues from their legacy domestic audience. SO Germany and France are keen on enforcing a fiscal union or similar arrangment to take away one of the advantages of smaller economies.