If the European Monetary Union (Eurozone) relaxed the budget restrictions on national governments that are applicable under the Stability and Growth Pact (3 per cent deficit to GDP ratios and 60 per cent public debt to GDP ratios) then the current solvency risk facing several EMU members would be resolved.
Answer: False
The answer is False.
Linking of solvency risk and the Stability and Growth Pact is false.
The Stability and Growth Pact which is summarised as imposing a rule on EMU member countries that their budget deficits cannot exceed 3 per cent of GDP rule and their public debt to GDP ratio cannot exceed 60 per cent. In the links provided below you will find extensive analysis of the nonsensical nature of these rules.
The SGP was designed to place nationally-determined fiscal policy in a straitjacket to avoid the problems that would arise if some runaway member states might follow a reckless spending policy, which in its turn would force the ECB to increase its interest rates. Germany, in particular, wanted fiscal constraints put on countries like Italy and Spain to prevent reckless government spending which could damage compliant countries through higher ECB interest rates.
In a 2006 book I published with Joan Muysken and Tom Van Veen - Growth and cohesion in the European Union: The Impact of Macroeconomic Policy - we showed that it is widely recognised that these figures were highly arbitrary and were without any solid theoretical foundation or internal consistency.
The current crisis is just the last straw in the myth that the SGP would provide a platform for stability and growth in the EMU. In my 2008 book (published just before the crisis) with Joan Muysken - Full Employment abandoned - we provided evidence to support the thesis that the SGP failed on both counts - it had provided neither stability nor growth. The crisis has echoed that claim very loudly.
The rationale of controlling government debt and budget deficits were consistent with the rising neo-liberal orthodoxy that promoted inflation control as the macroeconomic policy priority and asserted the primacy of monetary policy (a narrow conception notwithstanding) over fiscal policy. Fiscal policy was forced by this inflation first ideology to become a passive actor on the macroeconomic stage.
But these rules, while ensuring that the EMU countries will have to live with high unemployment and depressed living standards (overall) for years to come, given the magnitude of the crisis and the austerity plans that have to be pursued to get the public ratios back in line with the SGP dictates, are not the reason that the EMU countries risk insolvency.
That risk arises from the fact that when they entered the EMU system, they ceded their currency sovereignty to the European Central Bank (ECB) which had several consequences. First, EMU member states now share a common monetary stance and cannot set interest rates independently. The former central banks - now called National Central Banks are completely embedded into the ECB-NCB system that defines the EMU.
Second, they no longer have separate exchange rates which means that trade imbalances have to be dealt with in monetary terms not in relative price changes.
Third, and most importantly, the member governments cannot create their own currency and as a consequence can run out of Euros! So imagine there was a bank run occuring in Australia, while the situation would signal mass frenzy, the Australian government has the infinite capacity to guarantee all deposits denominated in $AUD should it choose to do so. If the superannuation industry collapsed in Australia, the Australian government could just guarantee all retirement incomes denominated in $AUD should it choose to do so. The same goes for any sovereign government (including the US and the UK).
But an EMU member government could not do this and their banking or public pension systems could become insolvent.
Further, it could reach a situation where it did not have enough Euros available (via taxation revenue or borrowing) to repay its debt commitments (either retire existing debt on maturity or service interest payments). In that sense, the government itself would become insolvent.
A sovereign government such as Australia or the US could never find itself in that sort of situation - they are never in risk of insolvency.
So the source of the solvency risk problem is not the fiscal rules that the EMU nations have placed on themselves but the fact they have ceded currency sovereignty.
The following blogs may be of further interest to you: