STRATEGIES AND POLICIES FOR EU GROWTH AND STABILITY 2014

STRATEGIES AND POLICIES FOR EU GROWTH AND STABILITY  

To,

The Right Honourable European Parliament President,                           

It is a great pleasure writing to you again on how to make our economies permanently more resilient and which structural reforms and financial sector reforms can best to support growth in the EU. We are gradually returning to growth and employment but not desired level. It is time for economic and monetary integration in Europe as Europe’s financial sector undermine the stability of the European financial system and the European economy as a whole. What we need is an effective mechanisms of fiscal policy co-ordination at the EU level, fair and sustainable taxation, effectively address the macroeconomic and social imbalances on economic stability in the EU and the evolution of the international monetary relations and their implications for Europe. We need to comprehensively address the above-mentioned issues for building a more resilient and sustainable economic and monetary union in Europe.

EFFECTIVE MECHANISMS OF FISCAL POLICY COORDINATION IN THE EU

The Right Honourable President,

Broad coordination of fiscal policy across the Member States should play a central role in order to ensure the correct functioning of interest rate policy in monetary union as well as stipulating economic growth across Member States. If we failure to implement it could lead to difficulties in the implementation of monetary policy in the euro area as well as we won’t be able to build a more resilient and sustainable economy in Europe. Still fiscal policies of some EU Member States proved to be unsustainable as it limits to reduce the value of its foreign-held public debt. The lack of fiscal policy coordination clearly suggested the necessity of promoting more precarious economic policies in times of economic expansion and acting for preventing the accumulation of imbalances. Fiscal policy cordination provides the incentives for creating safety measures that will allow an adequate reaction to significant negative shocks. Mr. President, we are not promoting coordination of economic policy. We require to  move towards from fiscal point of view what is called medium term objectives which is said in terms of the structural budget balance. The structural budget balance plays a key part in the EU fiscal rules. No one discusses what should be the overall fiscal stance of the eurozone. Do we need fiscal stimulus at this stage in the cycle. How big the fiscal stimulus should be? As I have said earlier two years back in my European Commission call for papers, the driver should be at the country-specific level because each and every country may differ in terms of private debt and the target of public indebtedness. We need to design the fiscal stimulus at the country-specific level that achieve fiscal consolidation across Member States as fiscal policy coordination is positively raise tax revenue domestically.  But the recommendation of European Commission structural budget balance rule is not country-specific. The recommendation of the European Commission are much more binding for deficit countries particularly southern European countries than surplus countries. The European Commission thinks Germany has structural budget surplus but we cannot ask Germany anyway to ease fiscal policy to support European Union growth. Last year, we saw the report on macroeconomic imbalances in eurozone. The European Commission has pointed out that Germany had 7 percent GDP current account surpluses in the last two years. According to the European Commission the euro exchange rate is not in equilibrium for Germany and on the way to rebalance. You called on Germany to reduce current account surpluses but the fact is there is no mechanism to buying Germany to change its macroeconomic policy. Moreover, German policy makers not agreeable this idea. It is obvious all of these produces restricted overall policy stance and really doesn’t adopt. As a result, we are dwindling for our growth. The whole structure of the stability programme and fiscal compact are based on the concept of structural budget balance as I have said earlier. Now these balance is computed from the potential growth of the economy and the output gap of the economy. European Commission said that the potential growth rate of the Spanish economy this year will be -1.1 percent. The output gap was Spain is almost 3 percent. That means the Spain budget defict last year was around 6.7 percent of GDP. It means the structural budget balance of Spain receiving deficit by more than 4 percent of the GDP. If you take that mechanism by the both, it tells that Spain has to tightening the fiscal policy by more than 4 percent of GDP. Once again this is the receipe for stagnation for the contraction in essence we are not giving space any private for the structural reform that has to implemented in terms of what could be the growth potential. If Spain could have an output 8 percent or 10 percent higher than this year then we could explain most of its defict and we not need to require Spain to tighten fiscal policy. My point is if it is not possible to change fiscal compact, then we need to talk about how to better define the concept of the potential growth and output gaps. Output gaps would recover slightly faster than with other SGP rules (status quo and fiscal compact 1). So fiscal deficit countries in the European union more sensible fiscal target. We require deficit countries to raise sufficient tax revenue to meet the public expenditure as well as reduced deficit significantly.  

EFFECTIVELY ADDRESS THE MACROECONOMIC AND SOCIAL IMBALANCES ON ECONOMIC STABILITY IN THE EU

The Right Honourable President,

I would like briefly talk about ECB monetary policy. The primary objective of the ECB is price stability. The average inflation rate in the eurozone since started Euro is exactly 2 percent. ECB done a very good job in price stability. The point here is that on a forward looking basis the forcast is telling me the eurozone inflation is below target while at the same time unemployment in some of the Member States is more than 10 percent. So it is clear that ECB compare to other central banks is not doing enough. I do not have lot of hope we can achieve major changes in the near-term which is revisit mandate of the ECB in delight of the treaty. Here we do not need any treaty changes. We just need to the back entry European treaty. The primary objective of the ECB is price stability but ECB should also contribute to the goals of the European Union. One of the goals of the European Union is full employment. I would an argue it should be price stability and employment. I would argue it could be maximise employment subject to the inflation target that would make a big difference in eurozone growth. Remember Dr. Dragi became the president of the ECB the word unemployment was never mention in the statement of the ECB. We plenty to do in terms of macro economic policies. We should not settle for growth rate of just 1 percent particularly because we live in a world in which external environment is not very favourable.  

    

The Right Honourable President,

There are certain missing aspects in  monetary union. When we look at the monetary union the conditions for sovereign states actually stay together and have to do with their external balances. Monetary union is an extreme form to fixed the exchange rate system and fixed the exchange rate system will only work if there is external balance at least in the long-term to run as much money flowing out of the country as money flowing in the country which deserves means you have to commit to balance to trade. That means you can have debts and credits, you can have external finance but eventually it would be good that these debts are repaid not simply shifted around. This is exactly what has not occurred in the monetary union since the beginning it has been refereed to the original sin of the ECB. ECB had several convergence criteria none of these mention the balance of the payment. It was deliberately on the basis of the assumption that financial market would take care of the imbalances. It was assumed that through the creation of the common currency money would flow from the central to the periphery. It was also assumed this money would be efficently invested in productive undertaking and eventually go back to the central which is not happened. Since the beginning of the monetary union it is very clear separation between deficit and surplus countries. These imbalances within the eurozone have been to large extent I observed on the side of deficit countries . This is mainly consequence of depression not a step towards recovery. The fact that deficit countries have reduce their imports and increase their exports. On the other side surplus counties have to reduce their exports and increase their imports to balance but surplus countries have not increase their imports and domestic demand. It continues to be built up of net international investment positions and these have been fuelled, this is the case of Italy humilated financial account inflows leading after the crisis, then we had sudden stops of private inflows money fleeing from the periphery. What can be done to address these issues from the risk of impairing monetary union? One source of proposal that Haines made at Bretton Woods as International Monetary Systems. His proposal was in fact to create clearing systems with explicit goal of fecilitating the finance of temporary imbalances in external relations and avoiding the build up of major imbalances. The system which is quite similar TARGET 2 even here the idea was providing over draft to Member States that would allow Member States to fund temporary external imbalances simply by negative imbalances when they were imports and positive balances when they were exports. One major difference between the clearing union of Haines and TARGET 2 is that clearing union was supposed to be restricted to the current account wheras TARGET 2 is financing for current account and capital movements and of course, this is one major difference. It is the fact that Haines imagined within the clearing union only debtors countries was supposed to pay interest on their debts and creditors countries was supposed to pay charges on their credits. This should induce both debtors and creditors to converge towards equilibrium from both sides. This was the basic idea. Further idea is that the creditors are benefiting from these facilities just as the debtors because debtors are buying more than they could otherwise afford also the creditors are selling more than they could otherwise be able to sell. So they have the benefit of larger markets. This is of course another major difference with TARGET 2 where debtors countries pay and creditors countries earn in interest. Further point is that there should be focused maximum levels of positive and negative balances and eventually exchange rate adjustments in case of persistent imbalances. How can we refer to these principles and reform TARGET 2 in order to respond to these principles? Of course, We live in a very different environment with respect to post war II period where we had very tight capital control and we do not have importance of capital movements on financial markets. Of course, we cannot go for restricting the use of TARGET 2 imbalances just for current account because it would create major distruptions in the European banking system. We could do different refinancing operations according to the purpose if we financing trade or FDI perhaps ECB could refinancing operations almost favourable conditions to refinancing operations for movements on capital accounts. The idea of symmetric charges could I believe applied at TARGET 2 imbalances, of course it requires political consensus but I don’t think it departs from the principles of treaty, imposing symmetric charges on negative and positive TARGET 2 balances, of course, we cannot imagine imposing limit because the fact not having limits on TARGET 2 imbalances what saved eurozone in the first place we can perhaps impose increasing charges as country departs from equilbrium in both directions. Last point, we don’t have the lever of changing the rate of interest because the monetary union does not allow adjustment of nominal exchange rate, we have adjustment of real exchange rate but even here principle of symmetry should apply as we require deficit countries to adopt more restricted budgetary and wage policies. We should also effectively encourage surplus countries to adopt expansionary budgetary and wage policies in symmetric fashion. What would be the advantage of this system being? Very briefly, the fact of imposing sort of circulation rather holding tax an excess reserve at ECB would stimulate money circulation. Further advantage could be reduce external imbalances and avoid the fact of having external debts continiously being flowed shifted around and not paid out. Counties would converge through a cooperative mechanisms which I believe coherent with the principles of monetary union, debtors and creditors would be freed from deflationary pressure which of course burden for peripheral countries by re-precaution also cause slowing growth in central countries. Creditors would pay in proportion to the benefits that system provides to them. Trade and real investment would have achieve and stable source of funding independent from fluctuation of the condition of the liquidity on international markets. So it is different kind of money. It is not a money created exogenously by ECB, It is not a money created by market discipline, it is money created according to the needs of commercial transactions, according to the function that has to perform. Finally, if we have symmetric charges not simply shifting interest from debtors to creditors we are creating a source of funding that could be used for the purpose of international investment through the EIB or EIF.                                                           

FAIR AND SUSTAINABLE TAXATION

The Right Honourable President,

There are many challenges for the design of fair and sustainable taxation among Member States. Tax needs to raise enough revenue to finance public expenditure and maintain sound public finances among Member States and most importantly reducing fiscal deficit while doing as little harm to the economy as possible, we need to keep administrative and compliance costs low, we need to maintain horizontal equity across all tax payers including international tax payers, we need to address externalities and we need to support regulatory frameworks for pension saving, financial institutions etc. PIT remain good revenue raiser if the policy could maintained but how to reduce disincentives. PIT increase in all marginal rates likely to be a significant and stable source of revenue but reduced incentives for personal savings could increase vulnerability. SSCs also revenue raiser but how to address the demographic challenges on future role of a second tax on earnings. Overall, PIT, SSCs and consumption taxes remain good revenue raiser. VAT also good revenue raiser but there are concerns like distribution, distortion and fraud. Rising economy VAT is good but falling economy VAT is additional problem for government drag the revenue that happened in the EU and the estmated losses are €100 Billion in March 2013. CIT will also good revenue raisers but how to design tax on capital income in the face of tax competition. Low CIT and PIT not only attract investment but also tax base. We need to maintain strong revenue flows in order to reduce the Member States fiscal deficit. We are facing wide Member States differences in fiscal parameters. For that we need to distort investment decisions as little as possible. We need to make most taxes fairer. We should have high tax elasticity to attract FDI and allowance for corporate equity if it is possible. What I believe that implementation of economic reforms by european government in terms of its commitment and credibility to improve the business conditions and the investment climate across the Member States and the optimal debt reduction path are highly dependent on government commitment and credibility. We need to increase land tax which should be a stable revenue source. It may cause a reduction in land values which should reduce vulnerabilities by reducing foreign borrowing to purchase land. It is possible to mitigate this risk. We need to consider cut in tax rates on R & D, tax breaks on investment, cuts in tax rates on job choice and human capital investment and tax breaks on entrepreneurship for overall economic growth. If we increased taxes, output and income decrease which eliminates part of tax revenues which increase fiscal deficits because of lower output. I intend to conclude that our tax policy should reduce the gap between labour costs and disposable income of workers in the formal economy and replacement of taxes on nominal wages by increased VAT. In addition our tax policy should compete with advanced economies and generate more revenues.   

EVOLUTION OF INTERNATIONAL MONETARY RELATIONS AND THEIR IMPLICATIONS FOR EUROPE

The Right Honourable President,

The international monetary cooperation may be an effective determinants of growth differentials between countriers around crisis times. ECB exchange rate policies and of international monetary relations lagged far behind their actual economic importance. Therefore, international monetary policy coordination is not strong in ECB. For instance, when ECB loosens monetary policy to stimulate domestic demand, it will result in a depreciation of the exchange rate which can adversely affect the prospects of other countries by reducing demand for foreign goods. When other countries engage the same policy, the policies cancel each other out, resulting in excessive inflation but no gain in output. Similarly, an artificially depreciated currency creates powerful pressures for trade protection in trading partners and can threaten the very structure of international commercial relations. An artificially appreciated currency infecting other countries in the event of contagious currency crisis. The mechanisms of international payments and the mechanism of restoring disturbed equilibrium of balances are the basic problems of international monetary relations. Thus, international monetary relations often expressed in terms of currency clash or threats of competitive devaluation. What I believe, our monetary policy should not take account of developments of some other countries as it is quiet possible to detriment of our economy. If a change in our monetary policy leads to better performance in other countries, it should have developments on our economy, then, it is certainly be our interest. Otherwise, there is no need for international monetary coordination. If I am not mistaken, G7 economies monetary policies on track, thus there is no need for international monetary coordination at present. According to me, international monetary policy coordination is absolutely necessary around crisis times than normal times, hence gains are very small. Moreover, it is not easy to get world monetary policy makers to play the cooperative equilibrium as some countries monetary policy makers do not follow good policy. I would recommend that our monetary policy should focus more on domestic variables than international variables for our growth and stability at present.        

Thank you very much for your kind attention Mr. President.    

                                                                         ATHINARAYANAN SANJEEVRAJA

                                                                                                           JUNE 2, 2014

COPY TO EUROPEAN COMMISSION PRESIDENT AND EUROPEAN COUNCIL PRESIDENT