Greece and the United States: The Importance of Having a Credible Fiscal Framework

European leaders are meeting tonight to talk about Greece and the eurozone crisis. According to press reports, they will likely agree upon and announce steps to strengthen the eurozone’s fiscal framework. (We may read the steps described as improving the eurozone’s “economic governance”.)

Although these matters may seem minor and sleep-inducing to many, they are among the most critical that Europe can do right now to show the markets the eurozone crisis can be contained and managed – and for the right reasons that should give investors comfort.

The eurozone woes reflect several key challenges, but one of the most critical is that Europe did not (does not) have a strong enough fiscal framework. For all the Maastricht Treaty work, there were large gaps. The institutional speed bumps to prevent a Greece from ever occurring didn’t work for Greece. The government appears to have substantially misrepresented its fiscal situation at least twice, maybe more, to its fellow EU country members. It is important to have fiscal goals, but a country must have a sensible budget path that can be followed and communicated.  However, without sufficiently strong or workable rules to back up fiscal goals, a country is vulnerable to many of the type of problems Greece is experiencing.

The bodies charged with enforcing the fiscal goals of the Maastricht Treaty (the European Commission on the policy side, Eurostat on the statistical side) were not given sufficient authority (including an audit function or any corrective authority) and the EU country political leaders did not want to rock the boat in what appeared to be good times.

To move forward, Europe must strengthen its fiscal framework. We wish the EU leaders well this weekend.

There are important lessons coming from the other side of the “pond” for Americans. Although there are fundamental differences in the sovereign debt situations of the United States and Greece, there is a common lesson: it is crucial for countries to have not only a fiscal framework but also a credible fiscal framework. Without one, a country can is very easily be under fire, especially in tough economic times.