This volume brings together the papers and panel contributions presented at the conference on ‘The Euro Area and the Financial Crisis’, held in Bratislava from 6 to 8 September 2010. The conference was hosted by the National Bank of Slovakia and jointly organised by the National Bank of Slovakia, Heriot--Watt University in Edinburgh and Comenius University in Bratislava. The event was characterised by intensive discussions between central bankers, academics and policy-makers from all over Europe, which contributed directly and indirectly to the authors’ revisions of their papers. The basic question was: What are the implications of the financial crisis and the great recession for the future of the euro area?

The book begins in Chapter 2 with the keynote contribution by Governor Athanasios Orphanides on the issues surrounding financial stability in Europe. Part I addresses the experience of the crisis. Thorvardur Ólafsson and Thórarinn Pétursson try in Chapter 3 to identify the factors that caused the depth and duration of the crisis to be larger in different countries. Philip Lane in Chapter 4 focuses on the Irish case. Angel Gavilán, Pablo Hernández de Cos, Juan F. Jimeno and Juan A. Rojas in Chapter 5 examine the Spanish case. Aurelijus Dabušinskas and Martti Randveer in Chapter 6 consider the varying experiences of the Baltic countries. Part II considers the issue of accession to the euro area by countries in Central, Eastern and Southeastern Europe (CESEE). Biswajit Banerjee, Damjan Kozamernik and L’udovít Ódor in Chapter 7 analyse the different strategies for entry to the euro used by Slovakia and Slovenia. Miroslav Beblavý in Chapter 8 investigates whether euro entry was associated with significant rises in prices (especially for non-tradable goods and services) in Slovakia. And in the first panel contributions Governor Ewald Nowotny in Chapter 9 and Zdeněk Tůma, together with David Vávra, discuss in Chapter 10 whether and how CESEE countries should accede to the euro. Part III looks at the future of the euro area. Francesco Giavazzi and Luigi Spaventa in Chapter 11 argue that much more attention needs to be paid to current account deficits within the European Monetary Union (EMU). Daniele Franco and Stefania Zotteri in Chapter 12 consider the role that national fiscal rules could play in avoiding future problems. Thomas F. Huertas in Chapter 13 discusses mechanisms for ‘bail-in’ as an alternative to future bail-outs of financial institutions. Laurent Clerc and Benoît Mojon in Chapter 14 review the conduct of monetary policy in the euro area since the inception of the euro and the challenges that the Eurosystem has faced since the financial crisis. Boris Cournède and Diego Moccero in Chapter 15 assess the contribution that a price-level (as opposed to an inflation) target could make to the operation and performance of monetary policy. This is followed by contributions by Wendy Carlin, Vítor Gaspar, Stefan Gerlach and Jacques Mélitz to the second panel (Chapters 16--19), on how to restore confidence in the euro project.

Athanasios Orphanides in his opening keynote address affirmed that the global crisis revealed fault lines in the governance of the euro area. He concentrated on the new architecture for financial stability in Europe. In my brief contribution I want to focus on fiscal sustainability and budget discipline.

Demographic transition, the global crisis and debt levels

Before focusing on the specific case of the euro area I want to comment very briefly on a crucial evolutionary driver that will shape budgetary trends for the next several decades: demographics. The world is experiencing a fundamental demographic transition: according to the latest demographic projections, made available by the United Nations (2009), world population will stop growing by 2050, when it will have reached about 9 billion people (compared to almost 7 billion in 2010). This will interrupt a trend of pronounced population growth recorded for centuries. This constitutes an epochal transition, with profound impacts on economic, political and social balances.

Introduction

The euro was ten years old in 2008. To celebrate this important birthday the European Commission produced a 350-page report (European Commission, 2008), accompanied by a string of research papers, to evaluate the European Monetary Union (EMU) experience after a decade. Lights and shades emerged from a careful and thorough analysis of the relevant issues, but the overall conclusion was that EMU is ‘a resounding success’. Though perhaps more soberly, most observers would have subscribed to this view, ready to shelve some issues that, hotly debated when EMU was first launched, seemed now to have lost relevance: the effects of asymmetric shocks when optimum currency area conditions are not satisfied, the dangers of uncoordinated fiscal policies, the Walters (1986) critique of a ‘one-size-fits-all’ single monetary policy. One of the questions examined in the report, and at first sight somewhat reminiscent of the issues raised by Sir Alan Walters, was that of persistent differences in growth and inflation between some countries and the rest of the euro area. Misgivings on the sustainability of these trends were expressed here and there, but on the whole the policy conclusion was broadly reassuring:

Introduction

Central banks are usually assigned two main goals: the most recent one, which has become their priority objective over the last three decades, is price stability; the second one, which is historically their raison d’être, is to ensure the integrity of payments. In modern economies, this takes the form of the smooth functioning of interbank exchanges on the money market, which contributes to and depends on the maintenance of financial stability.

In accordance with economic theory, central banks have assigned specific instruments to each of these two objectives. The short-term interest rate has emerged, over the last three decades, as the main instrument with which monetary policy pursues its price stability objective. Central banks support the functioning of the money market through a continuum of instruments, ranging from their marginal standing facilities to the granting of liquidity assistance to troubled money-issuing institutions or lender of last resort (LOLR) to the financial system as a whole. These operations can, however, be sterilised in order to insulate the stance of monetary policy. Looking back at the first twelve years of the euro, this separation in the pursuit of the two objectives, which is consistent with the Tinbergen principle, has not been challenged until recently when short-term nominal interest rates reached their (zero) lower bound in 2009. The Eurosystem then, along with many other central banks throughout the world, embarked on non-conventional policies. The circumstances of the financial crisis and the great recession blurred the separation between the means mobilised by the euro area central bank in the pursuit of its two objectives.

Policy positions and committee structures in the European Parliament

The fact that the European Parliament (EP) is the only directly elected legislative body in the European Union (EU) gives its policy demands considerable weight in the decision-making process. Under the co-decision procedure, which is now the ordinary procedure, the EP’s formal decision-making power equals that of the Council of Ministers. Even when the consultation procedure applies, the EP appears to influence decision outcomes via the influence it exerts on the Commission (Nugent 2006: 404; Thomson and Hosli 2006b: 414; Kardasheva 2009).

This chapter examines the relevance of two general theories of legislative decision-making to explain variation in the EP’s policy demands. The first theory is the informational theory of legislative committees (e.g., Gilligan and Krehbiel 1989; 1990; Krehbiel 1991). According to this theory, on any given issue the policy position of the chamber as a whole is an unbiased representation of the policy positions of all parliamentarians. The second theory is the distributive theory of legislatures, according to which legislative organization, in particular committee structures and associated procedures, bias the policy positions of legislative bodies (e.g., Ferejohn 1975; Shepsle and Weingast 1987; Weingast and Marshall 1988).

The following 125 legislative proposals are included in this study. See Chapter 2 for details of the selection criteria. Asterisks indicate the sixteen proposals on which Costello (2009) collected detailed data on the policy positions of European Parliament (EP) groups, data that are examined separately in Chapter 5. The dataset will be available at http://www.robertthomson.info.

Agriculture

Proposal for a directive laying down minimum standards for the protection of laying hens kept in various systems of rearing 1998/092/CNS

Large and small; old and new

This chapter assesses the relative power of the member states in the Council. Part of this assessment considers the relative power of large and small member states. Small states may have considerable power relative to large states in the European Union (EU). Small states have the same voting power as large states when the Council must adopt a legislative proposal by unanimity. In addition, even in policy areas where qualified majority voting (QMV) applies, small states have more power than their formal voting weights imply (e.g., Bunse et al. 2005). However, many observers hold the view that large states dominate the small in the EU. A realist view of EU decision-making attributes greater power to the larger states (e.g., Pedersen 1998). Even researchers who recognize that small states have considerable weight in the decision-making process also note that the large generally have more power than the small (e.g., Hayes-Renshaw and Wallace 2006: 252).

What is the relative power of old and new member states? The answer to this question is partly conflated with the assessment of large and small states’ relative power, because most of the new member states are small. In addition to their small size, new member states face the challenge of adapting to, and integrating into, the EU’s system of decision-making. The process through which policy demands are transformed into decision outcomes is defined by informal bargaining. To participate effectively in such informal processes, state representatives need strong relationships with representatives of other states. Such relationships take time to form. Consequently, new member states may be at a disadvantage to old members, at least in the period soon after their accession. It has been suggested that new member states have not had a marked influence on decision outcomes (Goetz 2005: 254), which may indicate that they have less power than the old members.

The previous chapters examined the inputs, processes and outputs of the political system of the European Union (EU) with theories and methods of modern political science. Each chapter focused on an important aspect of the political system. It is now time to bring together the main findings and consider their implications. The three sections of this chapter summarize the main findings and dwell on their implications for three areas of knowledge regarding EU politics: enlargement, the democratic deficit and proposals for improving how the EU works.

Continuity and change in European Union decision-making since enlargement

There has been more continuity since the main 2004 enlargement than some observers and practitioners feared there would be. Three defining characteristics of the political system that helped make the EU successful have endured. First, inputs are diverse. Part I of this book examined inputs in the form of political actors’ policy demands regarding controversies raised by legislative proposals. There are only weak structures in these policy demands. This means that two member states that disagree with each other on one controversy are likely to agree on another controversy, even on a related matter. Variation in political actors’ policy demands is central to pluralist democratic theory (Dahl 1989: 251–4). According to pluralist theory, decisions are not controlled by a powerful elite group of actors with similar policy preferences on most of the important issues dealt with in the political system. Instead, different groups of actors share similar preferences depending on the issue at stake.

From inputs to outputs

How are diverse policy positions transformed into decision outcomes? This chapter examines the extent to which different theories accurately predict decision outcomes in the cases selected. Chapter 1 summarized the formal decision-making rules in the Treaty of the European Union (EU) that structure the decision-making process, such as the Commission’s right to initiate proposals, voting procedures in the Council and the involvement of the European Parliament (EP). Such formalities are at best the start of an answer to the above research question. To assess the impact of formal decision-making rules, we will identify the implications of those rules for decision outcomes, given the policy demands made on each controversy. The analysis will also consider alternative accounts of the decision-making process that attribute less importance to the formal rules, and that instead focus on informal bargaining among political actors.

This chapter uses a modelling approach to compare the relevance of different explanations of the EU’s decision-making process. Each explanation is specified in such detail that it makes specific predictions of what the decision outcomes will be given the distributions of actors’ initial policy positions on the controversial issues. This approach allows the analysis to compare the accuracy of different explanatory models’ predictions of decision outcomes. The analysis also identifies the extent to which alternative models differ from each other in their predictions of decision outcomes.

Supranationalism versus intergovernmentalism

This chapter answers the question ‘who has power in the European Union (EU)?’ by assessing the power of the Commission, European Parliament (EP) and Council relative to each other. During the process that transforms policy demands into decision outcomes, actors attempt to influence each other so that their policy demands are incorporated into outcomes as much as possible. Actors may differ from each other in their potential to exert such influence; in other words, they may differ in power. Researchers and practitioners express a wide range of views on the distribution of power among the Commission, EP and Council. The impact of EU enlargement on the distribution of power among these three institutions is also uncertain.

A classic definition of power that gives an appropriate point of departure for this chapter is that it is the potential a person or group has ‘to realize their own will in a social action even against the resistance of others’ (Weber 2007/1914: 247). This simple definition holds a number of insights that are highlighted by later definitions and discussions of power. First, Weber’s definition implies that the focus of power is on influencing ‘social’ or collective actions. In the context of the legislative process, this implies that the focus of power is on influencing the contents of legislative acts. Influencing other actors may be an important means to the end of influencing the contents of legislative acts, but this is not always necessary. By contrast, Dahl’s often-cited definition of power focuses on interactions between actors, rather than outcomes: actor ‘A has power over [actor] B to the extent that he can get B to do something that B would not otherwise do’ (Dahl 1957: 203). Depending on the decision rule, it is not always necessary for actor A to convince B to change its behaviour for A to influence decision outcomes. For instance, under the co-decision procedure, the Council and EP could in principle change the legislative proposal and adopt an act that the Commission does not support. Therefore, it is not necessary for the Council and EP to change the Commission’s behaviour to influence the decision outcome.

A supranational technocrat, a party political ideologue or a multinational?

This chapter examines the European Commission’s policy positions in more detail. The main explanatory question is the following: What factors explain variation in the Commission’s policy positions? In answering this question, this chapter explores the effects of characteristics of the commissioners who were responsible for formulating the Commission’s positions on each controversy. This chapter examines the effects of commissioners’ ideological, party political and national affiliations.

The Commission’s policy positions are particularly important in the legislative process of the European Union (EU), not least because the Commission has an effective monopoly on the introduction of legislative proposals. Although the Commission cannot refuse to introduce a legislative proposal if requested to do so by the Council or European Parliament (EP), neither of these other bodies can determine the contents of the proposal (Crombez et al. 2006: 331). The fact that the Commission formulates and introduces legislative proposals gives it the potential to exert considerable influence on decision outcomes. The EU’s rules of procedure stipulate that the Council can only amend the Commission’s proposal unanimously when the consultation procedure applies. Potentially at least, this means that the Commission can use the rules of procedure to ensure that decision outcomes are a close as possible to its policy preferences. We will examine this agenda-setting power in more detail in Chapter 7.