April 10, 2017

Chart of the week: No major member of the euro area now meets the Maastricht criteria

by Fathom Consulting

The critique of a monetary union without a fiscal union is well known, not least in the euro area, and dates back at least to Alan Walters, adviser to Margaret Thatcher in the 1980s. Those who laid the groundwork for the single currency area perceived another over-riding risk – the risk that fiscal profligacy in some member states could undermine the fiscal solvency of the euro area as a whole, since membership of a currency union carries with it an implied underwriting of individual sovereigns by the common lender of last resort, the ECB.

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That was the motivation for the Maastricht criteria, which threatened sanctions on any member state who breached certain limits on the government deficit or government debt. For a country to be able to adopt the single currency, it first had to comply with the Maastricht criteria – something that all EMU members initially achieved, with the exception of Greece, who only pretended to have achieved it. Today, though, none of the major member states would meet the Maastricht criteria for euro membership.

As our chart highlights, it is not just the periphery whose fiscal position has deteriorated – it is also France, Germany and other core members. Along the way, the peripheral member states (governments and private sectors) borrowed far beyond their means – our analysis suggests that the net present value of the total stock of peripheral (including Italian) sovereign debt will ultimately have to be reduced by at least 1.5 trillion euros. In spite of that profligacy, markets were profoundly relaxed about the risk of default on that debt ahead of the global recession, with spreads between peripheral and German sovereign debt narrowing almost to zero.

The banking crisis changed all that, and widening spreads threatened imminent collapse of the EMU ahead of Draghi’s speech in 2012. That speech saved the euro – at least until now. Spreads have narrowed, but underlying structural problems remain in place, and the divergence between the member states of the euro area is still unsustainably large. That divergence is unlikely to disappear of its own accord, and the last few years show that it strengthens the political momentum of parties across the euro area who are committed to withdrawal.

For now, the euro area will continue muddling along. But in the end, the structural problems will have to be resolved. Without structural changes, the current up-tick in short-term cyclical indicators will prove to be just another in the sequence of ‘saw-tooth’ bumps in growth that have characterised the euro area since the recession, and Japan for the last twenty-five years.

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