MACROECONOMIC POLICY COORDINATION

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MACROECONOMIC POLICY COORDINATION

• Prof. Dr. Jovan Pejkovski

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• Coordination is a fundamental principle for
  economic policy in the EU.
• There is a consensus that soft coordination
  (exchange of information, general guidelines for
  economic policy) is useful. Whether stabilization
  policies should be coordinated is another matter.

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• The term "policy co-ordination" is being used for
  a variety of cases. Fiscal policies can be
  co-ordinated amongst EU Member States to avoid
  negative externalities.

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• Coordination of monetary and fiscal policies at
  the euro-area level may facilitate obtaining a
  policy mix that is well geared to the prevailing
  economic situation.
• Finally, consistent and mutually enhancing macro-
  and microeconomic policies will be conducive to
  the overall economic performance.

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• LEGAL BASIS are
• Articles 2, 4, 98-104 introduced by the Treaty of
  Maastricht and Articles 125, 126 EC introduced
  by the Treaty of Amsterdam.
• Protocol on the Excessive Deficit Procedure
  annexed to the Treaty.

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• OBJECTIVES
• Treaty provisionsArticle 98 is the basis for
  coordination, requiring the Member States to view
  their economic policies as a matter of common
  concern and coordinate them within the Council.
• Subsequent articles prescribe the areas and forms
  of coordination. Article 99 lays down the
  procedures related to the general policy
  recommendations (Broad Economic Policy
  Guidelines). Article 100 is concerned with
  special provisions applicable in cases of serious
  economic difficulties.

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• Articles 101 through 103 rule out privileged
  access to financing from the European Union or
  the European Central Bank (ECB) to any public
  body.
• Article 104 contains the basis for subsequent
  secondary legislation with regard to budgetary
  discipline. The thresholds for the level of
  public debt and deficit are defined in a separate
  protocol to the Treaty (Protocol on Excessive
  Deficit Procedure).

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• Article 104 also lays down the procedure to be
  followed if a Member State does not fulfil the
  deficit or debt criteria.
• The Title on employment, introduced in the Treaty
  of Amsterdam, establishes employment policy among
  the fields of economic policy coordination
  (Articles 125 and 126).

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• Aims
• Contribute to the attainment of Treaty
  objectivesThe overall objectives of economic
  policy coordination are those of the European
  Union, seeking to secure balanced, sustainable
  and non-inflationary growth, associated with high
  employment and competitive industry in a market
  economy setting.
• This should lead to higher standards of living
  and quality of life together with increasing
  convergence of economic performance across Member
  States.

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• Tune national fiscal policies to single monetary
  policyThe Euro area is a monetary union where
  the currency area does not coincide with the area
  of budgetary sovereignty. Policy coordination is
  needed to combine one monetary policy, pursued by
  an independent central bank, with fiscal and
  structural policies, for which each Member State
  remains responsible.

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• Draw maximum benefit from economic
  integrationThe EU is highly integrated in terms
  of trade and investment flows. The high degree of
  interdependence between the national economies
  needs to be taken into account because it
  increases the influence of one Member State's
  policy decisions on the evolution of the others'
  economies.
• Successful coordination guarantees that such
  spillover effects are taken into account in
  policy design, enabling the advantages offered by
  a well-functioning large internal market to be
  fully exploited.

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• Achieve economic convergenceThe coordination of
  structural policies, i.a. in product and labour
  markets, seeks to foster long-term convergence of
  national economies since their evolution
  determines the direction in which the EU economy
  will develop

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• Scope of coordinationThe scope of economic
  policy coordination is wide but not precisely
  defined. It can be seen as encompassing all
  actions aiming to provide economic conditions for
  balanced and sustainable growth within the EMU
  and the EU. Its main elements should be
• a common assessment of the economic situation
• agreement on appropriate policy responses in the
  short run and in the long run
• acceptance of peer pressure and, where necessary,
  adjustment of policies pursued.

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• ACHIEVEMENTS 
• Decision-making frameworkEconomic policy
  coordination is mainly based on consensus without
  legally enforceable rules, except in the fiscal
  policy framework. In other areas the means
  employed consist in information exchange,
  discussion, peer review and, where appropriate,
  commonly agreed goals with common actions.
• The key concept of 'open method of coordination'
  was coined by the Lisbon summit of March 2000,
  with the European leaders encouraging the Member
  States to set benchmarks, identify best practices
  and implement policy in line with these.

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• The legal framework for economic policy
  co-ordination, developed since Maastricht, is
  based on
• Council Regulation 3605/93 on the application of
  the excessive deficit procedure and
• the Stability and Growth Pact.

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• Further framework for coordination is defined by
  decisions taken by the European leaders in the
  European Council.
• These decisions have created a "soft" legal
  basis for policy co-ordination in various areas
  or have made it more explicit

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• employment conclusions of the Luxembourg summit
  of November 1997
• structural policies conclusions of the Cardiff
  European Council of June 1998
• strategic goals for structural reform to be
  reached by 2010 conclusions of the Lisbon
  European Council of March 2000 and
• the Resolution of the Cologne European Council of
  June 1999, establishing the Macroeconomic
  Dialogue.

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• ActorsThe European Council sets co-ordinated
  political priorities and gives guidelines at the
  highest level.
• The Member States are in charge of national
  reporting, exchange of information and the
  implementation of recommendations and decisions
  adopted by the Ecofin Council.
• The Eurogroup (the Finance Ministers of EMU
  Member States) discusses EMU-related matters
  informally, usually before the Ecofin Council
  meeting.

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• The ECB participates in matters linked to
  monetary policy.
• The Commission (in particular the Commissioner
  and the Directorate General in charge of Economic
  and Financial Affairs) is in charge of reporting,
  preparing and making recommendations, as well as
  of the follow-up of the implementation of
  decisions.

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• The Economic and Financial Committee (EFC) gives
  opinions and prepares the Council's work. So does
  also the Economic Policy Committee (EPC), which
  also contributes to the Commission's work.
• Finally, the Social partners are involved in
  their fields of main interest employment, wage
  developments and structural reform.

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• Main tools
• Overall Policy Coordination - Broad Economic
  Policy Guidelines (BEPGs)
• Nature and frequencyThe BEPGs is the central,
  overarching policy document for different areas
  of economic policy coordination. It covers both
  macroeconomic and structural policy issues. The
  ECOFIN Council adopts this strategic document,
  endorsed by the European Council, in early summer
  of each year on the basis of the Commission's
  recommendation.

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• As of 2003 the period for major revisions is
  increased to three years, reflecting the
  medium-term character of this strategy document.
• Only minor updating is to be made in between.

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• ContentThe purpose of the BEPGs is to give
  concrete recommendations to the Member States
  with regard to macroeconomic and structural
  policies.
• The document consists of two broad sections, the
  first devoted to orientations common to all
  Member States or all Euro area Member States and
  the second containing country-specific
  recommendations.

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• Legal statusThe BEPGs are not legally
  enforceable, but peer pressure exercised by other
  Member States is expected to make the
  recommendations politically binding. To step up
  the pressure, the Council can issue a
  recommendation to non-compliant Member States and
  make it public.

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• Implementation and follow-upSince 2000 the
  Commission publishes an annual Implementation
  Report to enhance the follow-up of the
  recommendations. The report aims to give more
  visibility to progress made or missed, permitting
  results to be taken into account when preparing
  the BEPGs for the following year.
• The Implementation Report also constitutes an
  important link between the BEPGs and the
  coordination of budgetary policies under the
  Stability and Growth Pact.

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• Relationship with sectoral coordinationIn order
  to guarantee the coherence of sectoral
  coordination - the so called "processes" -
  information must flow between them and the
  overall coordination based on the BEPGs.
• Input from the coordination in fields of
  budgetary policy and public finances, employment,
  structural reform and the general Macroeconomic
  Dialogue is used in the preparation of the BEPGs.
  Conversely, the recommendations issued in the
  BEPGs are to be applied when setting goals in
  other fields.

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• The Macroeconomic Dialogue - the Cologne
  ProcessThe Cologne summit of June 1999
  introduced bi-annual meetings of representatives
  of various European institutions and the social
  partners, called the Macroeconomic Dialogue or
  the Cologne Process.
• Its purpose is to be a forum for an exchange of
  views, thereby fostering a common assessment of
  the economic situation at the European Union
  level.

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• It is hoped that such exchanges will lead to
  stability-oriented wage claims and a balanced
  macroeconomic policy mix, supporting strong
  non-inflationary growth.
• The model for this procedure is the dialogue
  between management and labour organisations
  common in some Member States. The parties in the
  Macroeconomic Dialogue include the social
  partners, the Council, the Commission and the ECB.

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• Framework for fiscal policy - Stability and
  Growth PactThe purpose of coordinating budgetary
  policies is to ensure a sufficient degree of
  coherence between the Member States' fiscal
  policies, given the common monetary policy
  conducted by the ECB.
• The coordination of budgetary policies consists
  of multilateral surveillance and the Excessive
  Deficit Procedure, the rules for which are set
  out in detail in the Stability and Growth Pact.

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• Employment - the Luxembourg Process and the
  Employment Guidelines
• ProceduresThe Employment Guidelines constitute
  the centrepiece of this policy coordination
  process. The Council adopts this policy document
  on the basis of the Commission's proposal. The
  Member States are requested to take the
  Guidelines into account when formulating their
  national employment policies.

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• They must submit to the Commission National
  Action Plans (NAPs) on employment, which are
  examined by the Commission and the Council.
• The NAPs are an input to the Commission's Joint
  Employment Report and thereby to the following
  year's Employment Guidelines. Apart from the
  Member States, the European Parliament, the
  Economic and Social Committee and the Committee
  of Regions each provide an input to the
  Employment Guidelines.

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• Legal statusPolicy coordination in employment
  matters is a relatively weak coordination
  process. It is based on regular reporting, peer
  review and general guidelines issued to Member
  States.
• Country-specific recommendations can also be
  given, but they are not legally binding.

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• Reflecting this variety, in the EU co-ordination
  is used as an umbrella term. It encompasses an
  entire spectrum of interactions among policy
  actors.
• The range of methods applied includes information
  exchange, discussion of best practices, policy
  dialogue, commonly agreed policy rules and
  objectives, peer review and, when necessary,
  jointly determined actions.

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• Structural Reform - Cardiff Process and Lisbon
  targets
• Origin and contentThe aim of structural reform
  is to make product, labour and capital markets
  more efficient, thus promoting high standard of
  living and high quality of life for the European
  citizen in a globalised world.
• The progress in these fields is monitored in the
  Cardiff Process, named after the Cardiff European
  Council, which introduced the procedure.

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• ProceduresCoordination is voluntary and based on
  monitoring, the exchange of best practices
  between the Member States and peer pressure.
• The centrepiece of the process is a reporting
  system on the measures taken in improving the
  functioning of product and capital markets.
• Member States provide national reports annually,
  on the basis of which the Commission prepares a
  "Cardiff report" for the EU. This report serves
  as an input to the assessment of the
  implementation of the Broad Economic Policy
  Guidelines.

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• Speeding-up structural reform - Lisbon targetsIn
  the Lisbon summit of 2000 the Member States
  committed themselves to speeding up the
  structural reform process, in order to make the
  European Union the most dynamic economy in the
  world by 2010.
• Numeric goals were set to be reached by that
  year in areas such as employment and research and
  development.

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• The progress made in three years has been
  disappointing and it is widely agreed that a
  fresh effort is needed if the targets for 2010
  are to be reached.
• Since 2000 a special spring summit has taken
  place. It is a meeting of the European Council
  dedicated to economic policy, evaluating in
  particular the progress in structural reforms.

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• Coordination within the fiscal policy sphere is
  based on clear rules, backed up by a sanction
  mechanism if necessary. In the case of
  interactions between fiscal and monetary
  authorities, the methods most used are
  information exchange and dialogue.
• And as regards microeconomic policies and the
  structural reform process, the main instruments
  are analysis and monitoring to detect best
  practice, and peer pressure to speed up
  implementation.

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• Accordingly, policy competition -- by which means
  the test in economic reality of policies and
  structures in different Member States as to their
  capacity to enhance the economic performance --
  and policy co-ordination are not mutually
  exclusive.
• In fact, policy competition can be seen as an
  element in the broad spectre of economic policy
  co-ordination. In weak forms of co-ordination,
  policy competition plays an important role.

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• It can be argued that an important element of
  European economic integration, a single market
  with a single currency, includes and fosters
  competition between systems (e.g. fiscal regimes)
  and between structures (e.g. labour market
  institutions).
• This competition should lead to "best practices"
  effects for policies.

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• Why does co-ordination need to be strengthened in
  the EU?
• The key economic motivation for co-ordination is
  to take account of spill-overs of national
  policies.
• It enables internalisation of these spill-overs
  in policy making and therefore a better
  allocation of resources and higher potential
  growth.

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• The more likely and significant cross-border
  spill-overs of national policy are, the more
  reason there is for a comprehensive coordination
  framework. The importance of the spill-overs is
  strongly related to the extent of economic
  integration.
• On the other hand, co-ordination involves costs.
  Moreover, there is a need to preserve democratic
  legitimacy, to respect differing national
  preferences and the concept of subsidiarity.

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• The process of economic integration in the EU has
  moved into higher gear since the late 1980s. The
  drive to complete the Single Market by 1992 and
  the ongoing work by Member States to complete
  transposition of relevant Directives into
  national law has strengthened and is still
  strengthening trade links between the Member
  States.

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• The creation of EMU in 1999 has taken economic
  interdependence a step further. It has resulted
  in a unique institutional framework. A single
  monetary policy is entrusted to an independent,
  supranational central bank. However,
  decentralised economic policies remain in the
  hands of national actors.

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• Today, a policy line taken unilaterally by one
  country may impact the economic conditions of the
  others much more than in the past.
• A national policy action that affects, for
  example, the average inflation rate will in turn
  determine the ECB's decision on interest rates.
  This way the national policies affect all other
  EMU Member States.
• Strengthened co-ordination is needed to take
  account of these effects in national policies and
  particularly so within the euro area.

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• However, economic integration and policy
  spill-overs are not limited to the euro area. The
  whole of the EU is in a continuous process of
  increasing economic integration.
• Whereas in some areas additional coordination may
  be needed within the euro area, in general the
  whole EU is involved in strengthening economic
  governance.

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• To coordinate the policies that remain within
  national competence, a rather complex and
  elaborate system has been put in place. The
  appreciable complexity of the system is mainly
  due to the gradual approach by which the
  co-ordination framework is being developed.
• New procedures are added when deficiencies are
  exposed in experiences with prevailing
  procedures.

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• The drawback of this high complexity is that very
  few specialists know and understand the
  procedures. There is scope to streamline and
  simplify the procedures.
• And coherence between the policy recommendations
  of the various procedures should become a key
  priority.
• Otherwise we risk that a multiplicity of
  incongruent voices confuses the public,
  endangering the credibility and effectiveness of
  the whole co-ordination framework.

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• The European Council has repeatedly confirmed
  that the Broad Economic Policy Guidelines (BEPGs)
  are at the centre of economic policy coordination
  and give coherence to the framework. They contain
  orientations for the general conduct of economic
  policy and make specific recommendations to each
  Member State and to the Community.

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• The BEPGs' general policy orientations are
  developed further by more specialised procedures,
  which need to be consistent with the former.
• Among these, the Stability and Growth Pact deals
  with budgetary policy the European Employment
  guidelines with labour market policy the Cardiff
  process with product and capital market reforms
  and the Cologne process formalises the
  macro-economic dialogue.

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• Fiscal coordination
• The serious risk imposed by fiscal imbalances to
  euro-area wide stability and the obvious effect
  of national fiscal policies on the common
  interest rate makes the need for close
  coordination of macroeconomic policies, notably
  budgetary policies, undisputed. This has been
  reflected in the strong rules-based co-ordination
  in the Treaty and the Stability and Growth Pact.
• To address the most obvious threats to
  macro-economic stability stemming from the
  budgetary side, the freedom of national budgetary
  policies is constrained. Hence, excessive
  deficits of more than 3 of GDP are expressly
  forbidden.

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• Moreover, the SGP requires Member States to
  attain budgetary positions of "close to balance
  or in surplus" over the cycle. This is not only
  to ensure sound public finances in the long run.
  It also creates room for the automatic
  stabilisers to cushion economic fluctuations.
• Once the Member States have completed the
  transition phase to a medium term budgetary
  position of 'close to balance or in surplus', it
  enables (together with the flexible monetary
  policy) a smooth adjustment of the policy mix to
  changing economic circumstances.

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• In profound recessions, the leeway for
  stabilisation may be insufficient. In that case
  however, the Treaty provides an escape clause
  that allows budget deficits to temporarily
  overshoot the 3 of GDP ceiling.
• It should be clear that the Stability and Growth
  Pact is not an arbitrary legal constraint on
  fiscal policy. On the contrary, it is the
  operational application of general principles of
  sound fiscal behaviour.

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• Balanced budgets will allow to make speedier
  progress in reducing public debt as a percentage
  of GDP.
• In turn, this reduces the debt service burden and
  helps improving the structure of government
  budgets which is imperative in view of the
  consequences of the ageing of European
  populations and in an institutional setting with
  pension systems that are generally not funded,
  i.e. no capital has been accumulated to cover
  future pension liabilities.

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• In the field of fiscal policy coordination, in
  general the framework has functioned
  successfully. Admittedly, some problems have
  surfaced in a few Member States, but they stemmed
  from incomplete progress towards sound budgetary
  positions.
• This lengthened the transition to cruising speed
  or the steady state. In addition, we have always
  stressed that coordination is a learning-by-doing
  endeavour. Hence, the procedures are gradually
  streamlined and strengthened.

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• The surveillance process of the Pact has recently
  been improved with the adoption of a new 'Code of
  Conduct on the content and format of stability
  and convergence programmes'.
• It streamlined the procedure and extended its
  coverage to include the long-term sustainability
  of public finances.
• This is important in view of the budgetary
  consequences of ageing. Increased focus will also
  be given to the analysis of cyclically-adjusted
  budgets rather than nominal targets alone.

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• One of the basic questions facing the EU is how
  far macroeconomic policy coordination should go
  in various areas.
• This is a recurring theme in the discussion of
  economic policy in the EU, not least because the
  degree of coordination differs fundamentally
  among policy areas.

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• The economic interaction of various individuals
  or actors can be analyzed in a twodimensional
  space.
• One dimension relates to the nature of their
  goals the actors concerned may pursue one (or
  more) common aims. Alternatively, their actions
  and choices may be determined by contradictory,
  competing goals, as may be assumed in the case of
  consumersand producers.
• The second dimension relates to the nature of
  interaction, with a distinction being drawn
  between horizontal and vertical coordination of
  actors activities (see Fig 1)

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• Market coordination occurs when two (or more)
  actors interact on the same hierarchical level,
  in the absence of common goals. In this case,
  interests are reconciled by the price mechanism.
• For vertical coordination to occur, some actors
  must be clearly subordinated to others. This is
  true of the various parts of an organization
  (e.g. a firm), but can also be expected in
  macroeconomic policy processes where different
  policy fields are mutually dependent on each
  other.

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• Combination of common goals and horizontal
  coordination, occurs, for example, when
  interdependencies can be assumed between
  different macroeconomic policy areas controlled
  by independent agencies not subordinated to those
  state actors with relevant policy
  responsibilities (normally the government).

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• Where central banks or social partners enjoy
  independence, as the agencies of monetary and
  wage policy respectively, such horizontal
  cooperation becomes necessary.
• It should also be stressed that horizontal
  cooperation must be clearly distinguished from
  horizontal coordination of behavior in the
  absence of common goals, so-called antagonistic
  cooperation.

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• Is Coordination Possible?
• EU macro-dialogue seeks to initiate horizontal
  cooperation between three policy areas which in
  the Union are largely independent
• monetary policy, the responsibility of the
  ECB
• budgetary policy, the concern of the Ecofin
  committee and the Commission and
• incomes policy, which is a product of
  European social dialogue.

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• Policy coordination is therefore necessary when
  there are autonomous and non-unified
  decision-makers - with possibly incompatible
  (disjunct) preferences and objectives - and when
  their actions cause spillovers into each others
  jurisdictions.

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• Commonly, four arguments are made to explain the
  need for coordination and these potential
  benefits apply to both supply and demand side
  policies
• (1) National actions or policies may spill over
  directly into neighbouring countries. For
  example, state aids may cause distortions in the
  single market and must therefore be controlled at
  the European level.

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• (2) Indirect effects are particularly prevalent
  for European collective goods. Macroeconomic
  variables like inflation, interest or exchange
  rates concern all economic agents in Euroland and
  if independent national policy actions would
  cause the ECB to adjust monetary policy, the
  economic conditions in the whole area would be
  affected.

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• (3) Coordination should prevent or reduce the
  likelihood of free-rider behaviour by
  member-states.
• (4) Some political economy theories argue that
  policy coordination may be useful in deflecting
  criticism of unpopular but necessary policy
  action at the national level

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• Currently, the Member States are working on a
  number of improvements to further enhance the
  framework and the analytical input for
  coordination at large
• First, improving of the statistical and
  analytical basis for the euro area, which is key
  for a common and robust assessment of the
  economic situation.
• Improving euro-area statistics, but there are
  still insufficient activity indicators that
  provide a synthetic view of the euro area.
• A close and frequent evaluation of the
  euro-area's monetary-fiscal policy-mix is
  fundamental for analytical purposes.

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• Second, it is generally agreed that Member States
  could benefit from internal budget rules to
  better control the growth in budget expenditures
  and enhance the responsibilities of different
  levels of government. Spending rules would
  improve the budgetary discipline by allowing a
  closer targeting of structural balances.
• At the same time they would allow the automatic
  stabilisers to play, as its largest impact stems
  from the revenue side.

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• Third, the coherence and predictability of the
  coordination framework would benefit if actors
  behaved according to some general rules for the
  conduct of economic policies.
• These rules should lay down the principles on
  which policy instruments react to cyclical
  conditions or shocks.

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• One of the basic questions facing the EU is how
  far macroeconomic policy coordination should go
  in various areas. This is a recurring theme in
  the discussion of economic policy in the EU, not
  least because the degree of coordination differs
  fundamentally among policy areas.
• The monetary union implies a common, centralised
  monetary policy conducted by the European Central
  Bank.

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• The fiscal policy stance is determined
  nationally, but is subject to common rules on
  government deficits and debts with the aim of
  ensuring budgetary discipline according to the
  Maastricht Treaty and the Stability and Growth
  Pact, as well as to looser forms of coordination
  centred around the Broad Economic Policy
  Guidelines.

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• There is an ongoing discussion on the need to
  more closely coordinate fiscal policy
  stabilisation efforts among member states. There
  exists a similar discussion on tax policy, which
  remains an area for national policy making,
  although it is subject to some common rules
  restricting the freedom of action of national
  governments.
• Finally, some steps have been taken in the
  direction of coordinating structural employment
  policies, although these, too, largely remain a
  matter of national competence.