There was also some unease that small countries could be affected if the larger ones did not maintain discipline. Here, too, developments have given cause for concern, at least as regards the implementation of the regulations. Allow me to add a third argument. During the decades before the start of Monetary Union, economic policy in the EU was dominated by Germany. This was because of Germany’s size, of course, but it was also due to Germany’s economic success over several decades and its stable economic policies. There was almost a moral dimension to Germany’s actions. I still remember the meeting in the Monetary Committee when it became clear that Germany’s public finances in the coming years would be as weak as Italy’s. The dynamics in the room changed as if by magic. Since then no country has been able to take over the leader’s mantle. In such a situation peer pressure can easily turn into peer protection. Let me now turn to the future. In doing so I have tried to be constructive and limited myself to proposals I believe to be politically feasible. I will be happy to return to any of the subjects I will bring up. I. My first point concerns the division of labour and the cooperation between fiscal and monetary authorities. This is firmly established in the Treaty. The only uncertainty relates to the responsibility for exchange rate policy. Of course all parties must respect the existing rules.
The most obvious answer is to look at the stated rationale and motivation associated with the policy change. For example, the analysis by the Basel Committee on the long-term economic impact of stronger capital and liquidity requirements accepted the potential costs of higher loan spreads and reduced output levels, so this can be viewed as movement to the left along a frontier. It is also useful to think carefully about the expected impacts—both desired and undesired—and make ex ante predictions. What is the likely behavioral response? How might the balance sheet and the income statement change? What might financial markets reflect? At the risk of taking this simple framework too far, let’s think about what might happen to market indicators in each of two scenarios—a movement toward the frontier that makes policy more efficient and movement along the frontier toward a less conservative policy stance. If the former is really an elimination of inefficient constraints (move from C to B, for example), one might expect equity prices and Sharpe ratios to rise, while CDS spreads or bonds ratings are flat as opportunities expand and risk doesn’t increase. By contrast, in a movement along the curve, say from A to B, one might expect equity prices to rise as intermediation opportunities increase, while CDS spreads and ratings deteriorate as risk increases. One might expect to see measures of increased distress in some states of the world over time.