Charlie McCreevy, the Irish finance minister, no doubt believed he was doing the right thing with a ...
Charlie McCreevy, the Irish finance minister, no doubt believed he was doing the right thing with a Budget that cut taxes. His Fianna Fail party fights a general election next year, and the Irish, like most voters, will reward politicians who put more money in their pockets.
What McCreevy almost certainly didn't expect was that the wrath of Brussels would descend upon his head. Nor that he would provoke a full-scale debate about who is now in charge of making economic policy within the eurozone. That, however, is what he appears to have done.
Last week, the European Commission criticised Ireland for a Budget that encourages personal spending when it already has an inflation rate that is the highest among the 12 eurozone countries, and more than twice the target rate set by the European Central Bank. The Commission told McCreevy to spend less money and warned that the issue would be raised at the next meeting of Ecofin, the eurozone's finance ministers. In the aftermath of the EU's condemnation of his policies, McCreevy came out battling.
"There will be no policy changes vis-a-vis the Budget, which was laid down in December," McCreevy told Irish radio. "What the EU is intending to do is totally disproportionate. National governments have direct competency in terms of their own national budgets."
In identifying who has the power to decide national budgets, McCreevy went right to the heart of the issue. The introduction of the euro created a division of responsibility over the management of Europe's economy that needs to be resolved.
The European Central Bank, under President Wim Duisenberg, has the power to determine monetary policy for the eurozone and has an inflation target it is expected to meet. Fiscal policy, however, has been left in a state of limbo. Under the Maastricht and Amsterdam Treaties, which set up the rules for the single currency, national governments have the power to determine tax and spending policies within their own borders, but they do so within tightly proscribed limits set down by the Commission.
The difficulty arises when one member state decides to pursue policies that are far out of line with the rest of the eurozone.
That is what Ireland now appears to be doing. There is no doubt that Ireland has a significant inflation problem. In November, the year-on-year inflation rate reached 7%, and for the whole of 2001 it is forecast to run at 4.5%. That compares with less than 3% for the eurozone overall.
In its report on the Irish economy, the European Commission did not mince its words. "The budgetary plans for 2001 consist of indirect and direct tax cuts, and very large increases in current capital expenditure," it said. "As these measures will fuel demand, the overheating problem will continue."
There is room to doubt that judgment. In a recent assessment of the Irish economy, the Dublin stockbrokers Goodbody concluded: "Ireland is not going off the rails and inflation expectations should begin to moderate as headline inflation fades."
In his responses to the EU's criticism of his budget, McCreevy has argued that an economy growing at more than 10% last year and forecast to grow at more than 8% this year might well be expected to see its prices rise at slightly above the average rate as well.
But this argument is not really about economics it is about power. Right now, the Commission, the ECB and Ecofin are a collection of dragons that can breathe no fire. If McCreevy tells his fellow finance ministers to mind their own business, there is little they can do, no fines they can impose and no sanction apart from words. They can cajole and hector but cannot punish.
That is a weakness for the euro, a weakness the Irish rebellion will painfully expose. Monetary and fiscal policy do not have to be set by the same body but they do have to work in some sort of rough harmony. Otherwise you get chaos.
The risk is that individual countries will benefit from the ECB's overall monetary discipline, while rapidly inflating their own economies. That's called a free lunch, and one eaten at the expense of fellow eurozone members.
For the sake of its own credibility, the eurozone needs a better system than exhortation. Tax and spending cannot be set centrally as there is no political support among the member states for that. But Europe does need to find some way to punish members who let their fiscal policies run out control. And it needs to find a way of crushing the Irish rebellion, because if the Irish succeed in ignoring the rules, it is certain that many other countries will follow.
Matthew Lynn is in the London Bloomberg newsroom
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First mentioned in Cridland Report