Transcript

Transcript of a Teleconference Call by Michael Deppler, Director, European Department, IMF

February 15, 2005

MS. MBOTO FOUDA: Good morning, ladies and gentlemen. I would like to welcome all of you to this conference call of Mr. Michael Deppler, who is the Director of the European Department at the IMF, on "Reforming the Stability and Growth Pact." This conference call along with the paper, which was posted yesterday on the password-protected website for journalists, are embargoed until 10:00 AM Washington time today.

Mr. Deppler is currently in London. He will be taking your questions from there. I would also like to let you know that we have in this room here in Washington Mr. Jörg Decressin, who also works in the European Department on these issues. Mr. Deppler has a few opening remarks before we take your questions. Please go ahead, Mr. Deppler.

MR. DEPPLER: Okay. Thank you and welcome, everyone.

As you know, the Stability Pact is up for discussion and for reforms over the next few months, and the purpose of the paper we're issuing today is to give our thoughts on the matter.

There are two ways of looking at the issue. One is that, the Pact needs fixing; that is, there's something wrong with the Pact. This is not really our view. While the Pact is controversial, the problems with the Pact really are fundamentally elsewhere: in the fiscal policies of the countries concerned, which haven't been in conformity with the Pact in the past, especially in good times; and mostly because potential growth in productivity in the euro area has been weaker than anyone had really expected. And it's those two things that lie at the perceived weaknesses of the Pact. And the Pact is more a symptom than a cause. And if there's something to fix, it's really the underlying policies—fiscal policies, structural reform and boosting longer-term growth.

The other concern we have is that the context is not propitious. Basically a number of countries find themselves in breach of the 3-percent deficit limit or very close to it. And, moreover, they have elections coming up. This is not a context in which to think about fiscal policies.

Thinking about the Stability Pact requires a longer-term perspective, and the context is one where short-term perspectives loom large.

Now, what does the paper say? Well, the first thing is that from a medium-term point of view, the Stability Pact embodies the main elements of a good fiscal rule. In particular, I think the economic profession sees fiscal rules as essentially mechanisms to constrain the discretion of policymakers from acting out of short-term rather than long-term considerations. Fiscal rules sort of contain the deficit bias inherent in thinking about fiscal policies historically, and the Pact, from our point of view, represents a step forward and a step in the right direction for the euro area in thinking about fiscal policies. And if there's a need to fix it, it's more in regards to strengthening it rather than weakening the constraints on policymakers.

Now, what do we mean by weakening? What the paper says is, right now governments have considerable latitude to sort of weaken the discipline inherent in the Pact. There's a lot of room in terms of picking assumptions in growth, making asset sales, one-off operations. Indeed, misreporting has also been a problem. And some of the proposals under discussion would allow even more scope for these kinds of things to go on basically by allowing policy considerations to enter as exceptions to the tenets of the Pact. And in our view, this is sort of a step in the wrong direction from what's needed. It's going to push open further a gate that's now only sort of ajar and really should be closed.

Also, there are fancy things, proposals about making the Pact more suitable to individual country circumstances. We think these steps are a bit too fancy, and basically the present Pact, as far as we can see, is adequate to meet the circumstances. So we are concerned about some of these proposals as being in the way of weakening the Pact.

By the same token, there are some things we would agree are desirable. We would agree in particular that—and this is a point made in the paper—that when countries breach the 3-percent limit, when they enter the so-called excessive deficit procedure, the modalities there need to make a stronger distinction between the extent to which policies were at the root of the problem, at the root of the breaching of the 3-percent limit, and the extent to which it's just economic circumstances which led to breaches of the 3-percent limit. And this distinction is not really there right now, and we see a case for dealing with that issue.

The other step in the right direction from our point of view would be to increase the role of debt in thinking about what right fiscal policies ought to be, both from a medium-term point of view, but also as a cross-check on some of the gamesmanship that goes on with the deficit figures. You know, we see a lot of deficit figures which are reasonably good, but the debt figures rise more sharply than the deficit figures suggest. And bringing in debt would help to contain some of those things.

Finally, we also see a need to strengthen the incentives to adjust during the upswing. This is quite lacking in Europe and badly needed. Unfortunately, there's not much on offer in this regard except for more early warnings by the Commission, which is good, but in our view more is needed.

From this point of view, we think a big problem with the Pact is ownership at the national level. The Pact cannot be simply a Brussels operation. It has to have its roots in sort of national convictions and discussions and debates. And we support these ideas to have the Stability Pact discussed by parliaments. But we go further still and argue for independent, nonpartisan national fiscal councils which would assess and vet national budgets and stability paths from the longer-term perspectives for national parliaments. Basically mechanisms to make more transparency in budgets and sort of toughen the perspective on policymakers to act out of a short-term point of view.

In sum, you know, in our view, there are some things that could usefully be done to improve the Pact, but it's steps towards strengthening the incentives to take a longer view and not towards making it easier to accommodate shorter-term perspectives. And depending on the balance between these two things, we think no reforms would be better than short-sighted reforms.

But, more broadly, the ultimate source of the fiscal problems of the euro area lie not in the SGP but in the fiscal policies and the pace of structural reforms that are not keeping up sufficient growth. And this is where governments should be focusing, not on the Stability Pact, which has, in fact, in our view, properly fulfilled its function of being the alarm bell of the system.

I'll be glad to take your questions, and I'm in somebody's hands as to how to organize this.

QUESTIONER: Mr. Deppler, as you know, the German Government has demanded more flexibility in attributing the Stability and Growth Pact. For example, the high costs for reunification should be considered. How do you evaluate this request?

MR. DEPPLER: Well, our view is that, if you look at its history, the Pact really is viewed as rigid. But fundamentally, it's become more flexible with the practice of time. And, as I said, basically our view is that the countries undoubtedly face deep-seated problems, but those problems don't go away by simply changing the Stability Pact. Those problems go away by addressing them. And flexibility is not the answer to these countries' problems. Flexibility in the Pact is not the answer to these countries' problems. It's more a question of focusing on what those problems are and how to deal with them.

The one place where, as I said, we do see room for more flexibility is distinguishing between the role of policies and the role of circumstances when countries breach the 3-percent rule. That is a distinction which was not prominent in the past and pertained, I think, in the case of Germany. And I think there is merit to making adjustments there. So flexibility in that sense, yes, but in the sense of relaxing the longer-term constraints on policymakers, we would see a need to go in the opposite direction, if anything.

QUESTIONER: When you say economic circumstances might be considered, could you give an example where economic circumstances would justify a little bit more flexibility?

MR. DEPPLER: For instance, in 2003, Germany took a large set of measures with the approval of the council, but, nonetheless, the out-turn was still unsatisfactory by everybody's likes, but not because of the policies, but simply because the economy turned out to be vastly weaker than people had anticipated. And, you know, I think those kinds of distinctions, which were not inherent in the Pact but are becoming, I think, more accepted. And I think there's a fair amount of agreement on this, and we certainly agree with making those kinds of distinctions.

It's not to say, of course, that countries, if they have problems, don't need to do more. But there is a need to recognize that when they've done something, they have, in fact, done something, and that has not always been there.

QUESTIONER: So that means German request that the high costs of reunification are considered, you do not agree with that, Mr. Deppler. Am I right with that? And in the case of the Agenda 2010, you would say conversely that a little bit more flexibility is justified.

MR. DEPPLER: Well, no, I would say a fiscal situation—a breach of the 3-percent rule occurs against a certain background. To the extent that background is known and part of your evaluation of what the policy requirements are, there's no need to really sort of compensate for them some more. So, for instance, the costs of German unification, which are undoubtedly weighing on Germany, shouldn't be sort of a consideration arguing for more flexibility for Germany. That problem has been there for a long time and needs to be addressed. And so in our view, in the SGP, you know, the policies need to reflect that need and should make allowance for that.

The same would apply to some very specific circumstances where we think there is a case for more flexibility, particularly when it comes to pension reform where there are immediate fiscal costs offset by longer-term benefits, clear longer-term benefits.

Insofar as the 2010 reforms are concerned, we would say, no, not because in principle there isn't a link there, but ultimately what you want is a simple operational fiscal rule. And if you bring in the interdependence between budgets and structural reforms, you are opening a huge can of worms where economists simply do not agree on what the direction and especially the timing of the effects are going to be. And to bring those kinds of consideration into the SGP in our mind is simply going to weaken it from a longer-term point of view. And from the longer-term point of view, we see the SGP as basically the right constraint for the core countries of the euro area, all the countries of the euro area. And from our point of view, those longer-term constraints need to be kept out there.

QUESTIONER: I was just asking because you said in 2003 Germany has set up a great deal of reforms. So I think you were alluding to the Agenda 2010 in that respect.

MR. DEPPLER: No. No, no. I was alluding to the fiscal measures they took that year. They took 1 percent of fiscal measures that year.

QUESTIONER: Oh, I see. Okay.

MR. DEPPLER: And despite that, they still breached the 3-percent. So, I think there it's pretty clear to me that, they took the policies that everyone agreed were appropriate to the circumstances, or at least the council agreed to that, and so Germany shouldn't be held accountable for having still breached the ceiling under those circumstances since the breach was rooted in very weak growth developments that year.

QUESTIONER: I would like if you could elaborate a bit more on the debt and if you have in mind any figure or you agree with the 60 percent on the Maastricht Treaty that is a good target, or do you think that the European countries should reduce a bit more their debt.

MR. DEPPLER: In thinking about these issues, basically we take the Maastricht Treaty as a given. This is a treaty which would require the unanimous support of parliaments to change, and we simply take that treaty as a given.

Now, one of the features of that treaty is this 60-percent debt criterion. That debt criterion is not a normative one. It's cast as a maximum one, one that countries should meet.

Now, when you think of the Stability Pact, debt, in fact, is a factor which sort of plays relatively little role, and I think everyone agrees that the Stability Pact needs to take a more medium-term view, less focus on annual developments and more focus on longer-term developments. And injecting sort of debt consideration would help in that direction.

Now, we don't have a particular number in mind. I think everybody agrees that countries that are above 60 should be going down to 60, and indeed that countries should aim to be below 60. There's no magic number out there, and we certainly don't have any. But certainly when you think about the aging problems countries face, to the extent they don't address those problems, structural reforms, then, you know, there's a strong case for addressing it in part through fiscal adjustment and reducing debt now so as to be able to better afford the benefits from aging in the future. And so we are in support of that.

QUESTIONER: I wanted to ask a slightly political question, which is that the European central bank has made clear it is fairly unhappy with a lot of what it's seeing in the reform proposals. Do you think that this is going to be a problem for the policy mix if there continues to be a kind of rift over the reforms which the Finance Ministers and the Prime Ministers are politically able to agree themselves without taking into account the ECB's concerns?

MR. DEPPLER: I think the ECB is right to be concerned about the fiscal rules applying to the euro area over the medium term. But, the issue is what exactly are the changes going to be out there.

To the extent that they weaken the rule, basically that does sort of foreshadow, depending on the weakening, some increasing fiscal and monetary tensions in the medium term. But, frankly, I think, my view is we need to keep some perspective on this, and that is, fiscal policy in Europe is relatively well behaved relative to what we see in the U.S. and Japan. And in our view, the SGP has been one of the forces sort of helping to foster that result, and it needs to be protected. And I think in Europe, while we are concerned about making decisions, long-term decisions in this context, we're within a zone where I wouldn't see immediate risks from where we are now. But, nonetheless, I mean, the basic issue is policymakers accepting longer-term constraints even when it's a bit difficult in short-term circumstances, and that's the game.

QUESTIONER: Could you explain a little bit more how these independent fiscal councils would work? And as you said in the report, you always have some elections somewhere in some of these countries. Would these independent fiscal councils give some advice of what to do in election times?

MR. DEPPLER: Well, we would see them as permanently monitoring and reporting and assessing on the fiscal policies of governments, and doing so vis-à-vis parliaments but also vis-à-vis the wider public. And they should be doing this year in and year out, elections or no elections.

The basic issue is fiscal policy tends to get too much driven by short-term consideration, political consideration. And good fiscal policies in the end require some limits on the discretion of policymakers to act out of short-term considerations. And these councils would be independent. They would be professional. They would be nonpartisan. And they would sort of make their own assessment of what the government proposes.

You have these sorts of institutions in various places in Europe. The Central Planning Bureau does a somewhat similar function in the Netherlands. You find sort of somewhat similar things in Germany, but there, you know, I think the exercise is in a sense too immediate, too short term. There's a need for a longer-term perspective or more medium-term on fiscal issues and more debate about that and more enlightened debate about fiscal issues. And, it's very clear that, constraints on policymakers in some sense have to also come from the national debate, not sort of the Brussels debate. And the purpose of these councils would be to hopefully serve that function.

QUESTIONER: I wanted to ask you, looking at today's GDP figures for the euro zone, what your reaction was in light of the Stability Pact.

MR. DEPPLER: Well, as I said at the beginning, you know, the problems with the Stability Pact really are rooted far more deeply than in the Stability Pact itself. They are rooted in past policies which were quite expansive during upturns and then sort of came back and hit governments during downturns. And then the other thing is, clearly a development in Europe towards weaker growth over the past five years, weaker than, anybody expected.

Now, we are not pessimistic about the prospects for Europe. We see sort of a significant improvement in some of the fundamentals, and, looking to the medium term, we're not as pessimistic as some people.

Now, the figures we see today are rather mixed, I agree. I mean, some of the figures are good, for instance, France's and Spain's are quite good, but Germany remains very disappointing.

Here we're basically seeing an extended period of adjustment by the German economy to some of the problems it's faced, and that has to be taken into account. When we think about fiscal policies for Germany, this is what I mean about the distinction between policies and circumstance. You know, if German fiscal out-turns are weak because the GDP was very weak, Well, in a sense, Germany shouldn't be blamed for that. It shouldn't be, it argues for stronger structural policies for growth, but it doesn't necessarily argue for stronger fiscal policies in and of itself.

And so those kinds of distinctions are there, and that's how we would see the two related. But fundamentally, Germany is going through fairly harsh and early adjustment, and we expect that to be coming to an end. But clearly today's figures don't suggest we've quite turned the corner yet.

MS. MBOTO FOUDA: If we don't have further questions, we will stop the discussion here, and we thank all the journalists who have participated. We indeed thank Mr. Deppler who conducted this call from London.

We remind journalists that the embargo will be lifted at 10 o'clock, meaning in 25 minutes, Washington time. Thank you very much for participating.