The Eurozone Member States are not equivalent to currency-issuing governments in fiscal flexibility

I don’t have much time today for writing as I am travelling a lot on my way back from my short working trip to Europe. While I was away I had some excellent conversations with some senior European Commission economists who provided me with the latest Commission thinking on fiscal policy within the Eurozone and the attitude the Commission is taking to the macroeconomic surveillance and enforcement measures. It is a pity that some Modern Monetary Theory (MMT) colleagues didn’t have the same access. If they had they would not keep repeating the myth that for all intents and purposes the 20 Member States are no different to a currency issuing nation. Such a claim lacks an understanding of the institutional realities in Europe and unfortunately serves to give false hope to progressive forces who think that they can reform the dysfunctional architecture and the inbuilt neoliberalism to advance progressive ends. There is nearly zero possibility that such reform will be forthcoming and I despair that so much progressive energy is expended on such a lost cause.

The following claim was rehearsed by two MMT economists in an article they had published in the Review of Political Economy (published February 2024):

… while there was a problem with the original set-up of the Euro system, this has been resolved in the aftermath of the global financial crisis and the more recent COVID pandemic. The Euro area’s institutions allow some flexibility, allowing national governments to act as unconstrained currency issuers in times of crisis.

In conversations last week with some progressive non EC researchers and academics, I kept hearing the same narrative – ‘the European institutions work’, ‘the fiscal rules are flexible’, etc.

And that came from progressives voices rather than the technocrats in the European Commission, who reliably informed me that they were closing down the flexibility and reinforcing the discipline.

Just to set the scene here is a graph showing the relative unemployment rates for the EU27 countries, Euro20 countries, the UK, US, Japan, and Australia from the first-quarter 2000 to the first-quarter 2025.

The relative performance of the European labour markets is clearly inferior – and there is a reason for that.

The Eurozone Member States, of course, dominate the overall EU27 outcome.

The performance of the individual Member States is also generally poor.

In May 2025 the unemployment rates for 20 Member States of the Eurozone were:

Euro area 6.3 per cent
EU 5.9 per cent
Belgium 6.5 per cent
Croatia 6.1 per cent
Germany 3.7 per cent
Estonia 7.8 per cent
Ireland 4.0 per cent
Greece 7.9 per cent
Spain 10.8 per cent
France 7.1 per cent
Italy 6.5 per cent
Cyprus 3.6 per cent
Latvia 6.9 per cent
Lithuania 6.5 per cent
Luxembourg 6.7 per cent
Malta 2.7 per cent
Netherlands 3.8 per cent
Austria 5.3 per cent
Portugal 6.3 per cent
Slovenia 3.9 per cent
Slovakia 5.3 per cent
Finland 9.0 per cent

These unemployment rates are mostly elevated (by some margin) compared to most currency-issuing countries.

There is a reason for that.

Given time is short today, here is a brief summary of why the claims that the Eurozone Member States now enjoy fiscal flexibility such that they are indistinguishable from currency-issuing countries are unfounded.

First, the 20 Eurozone Member States use a foreign currency – the euro – as a result of surrendering their own capacity when they joined the Economic and Monetary Union.

The currency is issued by the European Central Bank, which is separate from any one Member State (see below).

That means that in order to spend the euro, a Member State government has to first raise taxes.

It also means, more significantly, that if a Member State wants to run a fiscal deficit, then they have to issue debt and rely on the bond investors providing the desired euros at yields that are set by the interests of the investors rather than any notion of population well-being.

Crucially, that debt comes with credit risk and the bond investors know that.

The risk is that the Member State may not be able to generate enough tax revenue to repay the outstanding debt when it matures.

There is no credit risk attached to the debt of Australia, Japan, the US, the UK etc because these governments can always through the monetary machinery of government meet any liabilities that are denominated in their own currency.

Spain, Italy and the rest of the 20 Member States do not enjoy that status.

Which means that the bond markets can ultimately make things difficult for a Eurozone state as we saw during the GFC.

Those who make the claims outlined in the Introduction claim that the ECB has shown its willingness to provide the currency necessary and control bond yields to preclude any insolvency arising.

It is obvious that during the pandemic the fiscal rules defined in the – Stability and Growth Pact (SGP) – were set aside in March 2020 through the activation of the so-called ‘general escape clause’.

There are in fact two clauses:

1. The unusual events clause,

2. The general escape clause.

The European Parliament briefing (March 27, 2020) that was issued when the Commission invoked the escape clause notes that:

In essence, the clauses allow deviation from parts of the Stability and Growth Pact’s preventive or corrective arms, either because an unusual event outside the control of one or more Member States has a major impact on the financial position of the general government, or because the euro area or the Union as a whole faces a severe economic downturn. As the current crisis is outside governments’ control, with a major impact on public finances, the European Commission noted that it could apply the unusual events clause. However, it also noted that the magnitude of the fiscal effort necessary to protect European citizens and businesses from the effects of the pandemic, and to support the economy in the aftermath, requires the use of more far-reaching flexibility under the Pact. For this reason, the Commission has proposed to activate the general escape clause.

Relaxation of the fiscal rules allowed EU member states to increase spending and incur larger deficits to mitigate the economic impact of the pandemic, without immediately facing penalties under the SGP.

Accordingly, for a short period the Member States could run higher fiscal deficits with the knowledge that the bond markets would not drive yields through roof.

Bond investors knew that the ECB would be buying virtually all the debt that was being issued by the individual Member States once it hit the secondary bond market which took all risk of the primary issue away and returned the market makers a tidy little, almost instant capital gain.

Interestingly, in my conversations last week, Commission economists told me they were surprised at how tentative the governments were in taking advantage of this temporary freedom.

Their scrutiny revealed that the policy makers in the Member States understood full well that the special SGP relaxation was temporary and that they anticipated that if they ran their deficits too far beyond the 3 per cent SGP threshold that the subsequent pain that would follow once the Commission resumed the enforcement of the – Excessive Deficit Procedure (EDP) – would be difficult to deal with.

Has this ‘freedom’ persisted?

Obviously not.

On March 8, 2023, the Commission released a memo – Fiscal policy guidance for 2024: Promoting debt sustainability and sustainable and inclusive growth – which noted that:

… fiscal policies in 2024 should ensure medium-term debt sustainability and promote sustainable and inclusive growth in all Member States …

The general escape clause of the Stability and Growth Pact, which provides for a temporary deviation from the budgetary requirements that normally apply in the event of a severe economic downturn, will be deactivated at the end of 2023. Moving out of the period during which the general escape clause was in force will see a resumption of quantified and differentiated country-specific recommendations on fiscal policy.

So – Protocol (No 12) – of the Treaty on European Union was back.

The operation of the EDP under – Article 126 – of the Treaty on the Functioning of the European Union is clear enough.

On July 26, 2024, the European Council, following the EDP rules launched the deficit-based EDP procedure against seven nations (deficits then in brackets):

Italy (-7.4%)
Hungary (-6.7%)
Romania (-6.6%)
France (-5.5%)
Poland (-5.1%)
Malta (-4.9%)
Slovakia (-4.9%)
Belgium (-4.4%)

See Council Press Release for more details – Stability and growth pact: Council launches excessive deficit procedures against seven member states (press release, 26 July 2024)Provision of deficit and debt data for 2024 – first notification – that informs the EDP.

We learned that:

Twelve Member States had deficits equal to or higher than 3% of GDP … Twelve Member States had government debt ratios higher than 60% of GDP …

So there will be more Member States added to those already tied up by the Commission in the EDP and varying austerity timelines will be imposed on them, which will prolong the elevated unemployment levels but also preclude sensible climate policy pursuits.

Further, there is a massive infrastructure deficit (crisis) in Europe as a result of years of austerity which the individual Member States haven’t a hope of addressing given the fiscal straitjacket they operate within is once again being enforced; that makes them vulnerable to domination by bond markets.

Moreover, the Member States are now being bullied by the European Commission (and Donald Trump indirectly) to ramp up military spending and the proposed – Security Action For Europe (SAFE) – under the ReArm Europe Plan will lumber them with more debt and even less fiscal latitude.

Second, no individual Member State in the Eurozone has legislative power to control the central bank – the ECB.

This is a very significant deficiency and we saw just how significant it was when in return for effectively funding the fiscal deficits of the Member States during the successive crises the ECB imposed crippling austerity conditions on the Member States.

The alternative would have been bankruptcy with no legislative recourse other than exit.

Of course, during the GFC, the European Commission feared that if one of the Member States was forced into insolvency because it could not repay outstanding debt upon maturity and/or could not afford the yields demanded by the bond markets for ongoing support as the fiscal deficits started increasing, the whole rotten system would collapse.

That is why they introduced the bond-buying programs.

But it was a political act rather than a progressive show of flexibility.

And we saw exactly what the ECB’s mentality was when the democratic trend in Greece in 2015 was indicating defiance of EC austerity stipulates.

The ECB used the threat of pushing the Greek banking system into insolvency, which led to the democratic will of the people being set aside and the so-called Socialist government turning neoliberal lackey and buckling to the oppression.

No such bullying occurs in nations that have legislative control of their central banks.

Further, the ‘once-size-fits-all’ interest rates spanning 27 economies that are vastly different in the timing and magnitude of their economic cycles means that monetary policy readily provokes economic instability.

We saw that clearly in the period before the GFC, when the ECB lowered rates because Germany and France were in recession (2004).

The lower rates, under other policy settings were inappropriate for the Southern states which were not in recession.

And the deliberate throttling of domestic demand in Germany meant that the growing trade surpluses were invested in property speculations in some of those Southern states, which came unstuck in the GFC.

Third, no individual Member State is able to control the euro exchange rate.

However, the nations with stronger trade fundamentals – meaning with surplus trade accounts – tend to dominate the dynamics of the euro foreign exchange rate and the weaker trading nations then have to accept that parity even if it would be totally at odds with the rate that would prevail if they had their own currencies and individual exchange rates.

This has been a longstanding problem in Europe since the beginning of attempts to integrate significantly different economic structures and cultures, first via the various failed attempts to fix exchange rates within the European community and then, more recently with the common currency experiment.

There is no suitable common exchange rate for the 20 Member States in the Eurozone and those with weaker trade fundamentals continually suffer competitiveness disadvantages that currency-issuing nations with their own flexible exchange rate avoid.

Fourth, those who make the claims in the Introduction then introduce another non sequitur to justify their unjustifiable assertions.

They say, for example, ‘look at the UK, they have crippling fiscal rules too’.

Or, ‘neoliberalism is everywhere’.

It is true that many nations outside Europe have succumbed to the neoliberal ideology and introduce voluntary fiscal rules as a political tool to convince voters that austerity is in their long-term best interests.

But unlike the European situation, these trends reflect the political fashion and can be varied if the fashion changes through a change of government.

In the case of Europe, the Treaties that define the legal framework that the EU operates within have embedded the neoliberalism.

That is, the ideology is embedded with the legal structure of the community that each Member State is beholden too.

That is an entirely different situation.

Article 48 of the Treaty on European Union (TEU) defines the process of treaty change.

The process is excessively rigid and no Member State can act alone to alter the rules.

And on matters of substance (which the economic rules surely are) there has to be a consensus of 27 Member States for any part of the Treaty pertaining to those matters to be changed.

The issues where the so-called ‘unanimity rule’ applies and where any Member State has a ‘right of veto’ include fiscal policy, foreign policy, and admitting new countries to the EU.

The short answer is that it would be nigh on impossible to reform the neoliberal economic ideology that is embedded in the legal framework of the EU and which governs the conduct of economic policy.

Currency-issuing countries like Australia might adopt neoliberalism but if it goes too far the government is dumped as we saw in May 2022.

Voters can dump their governments in Europe too but there can be no escape from the neoliberal ideology as long as they remain members of the EU.

Conclusion

I could (and have) written more on this topic.

The problem I see is that real resistance to the capricious and destructive neoliberalism of the EU is compromised by progressives who oppose that destruction but think that better days can be had through Treaty reform.

Even worse are those who mislead by claiming that the Treaties themselves are ‘flexible’ enough to render the neoliberalism optional, which, if true, would see Greece having the same opportunities as say Australia to improve the well-being of its citizens.

It isn’t true.

Can you imagine the Socialist Greek government holding a referendum as it did in 2015 which overwhelmingly voted against austerity then telling the Greek people they were dumb and that the government was going to ignore their wishes, if Greece had its own currency and central bank and the legislative clout choose their own economic course?

I can’t.

That is enough for today!

(c) Copyright 2025 William Mitchell. All Rights Reserved.