This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 FRANKFURT 010314 
 
SIPDIS 
 
STATE FOR EUR PDAS RIES, EB, EUR/AGS, AND EUR/ERA 
STATE PASS FEDERAL RESERVE BOARD 
STATE PASS NSC 
TREASURY FOR DAS SOBEL 
TREASURY ALSO FOR ICN COX, STUART 
PARIS ALSO FOR OECD 
TREASURY FOR OCC RUTLEDGE, MCMAHON 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EUN
SUBJECT: ECB on the Stability and Growth Pact:  Results or 
Call The Bluff 
 
T-IA-F-03-0065 
 
This cable is sensitive but unclassified.  Not/not for 
Internet distribution. 
 
¶1.   (SBU) Summary:  The European Central Bank (ECB) was 
exceptionally, sternly and publicly critical of Ecofin's 
decision on Germany and France under the Stability and 
Growth Pact (SGP), but has been careful neither to trash the 
SGP nor the process.  Rather, their message is that the SGP 
lives and that they expect Germany, France and Ecofin to 
live up to their commitments.  In the case of the two 
countries, this means that deficits be under 3% in 2005 and, 
failing to do so, Ecofin take measures under the procedures 
previously recommended by the Commission.  Putting a bit of 
monetary muscle into the mix, the ECB has listed "fiscal 
policies" as one of the various indicators it considers when 
assessing future inflation trends, although they are quick 
to point out this has always been so.  A Council Secretariat 
expert points out that, in fact, by "suspending" the 
proceedings, Ecofin wanted to be clear that it reserved the 
possibility to re-open proceedings and still apply 
sanctions, even though the time limit for doing so is to 
expire at the end of the year.  The question remains whether 
and on what evidence the Commission, the only entity that 
can recommend re-opening the proceedings, would do so.  Once 
burned, twice shy.  End Summary. 
 
ECB: Not Dead, but Alive 
________________________ 
 
¶2.   (SBU) Senior ECB officials have explained that while 
the ECB was very upset with Ecofin's decision under the SGP 
on Germany and France, they don't want to give the 
impression that the SGP is dead or they want to change it. 
Rather, they want the commitments made in the Ecofin 
decision to be respected. 
 
¶3.   (SBU) In its December Monthly Bulletin, the ECB's 
editorial reported that the Governing Council took note of 
the commitments made by France and Germany to "correct their 
excessive deficits as rapidly as possible and at the latest 
by 2005."  The Council also noted that the Ecofin Council 
"stands ready to give notice to the two governments to take 
measures that would lead to a correction of their excessive 
deficits."  ECB President Trichet was more direct in his 
press conference after the Governing Council's December 4 
meeting:  the Governing Council "noted that the Ecofin 
Council stands ready to take a decision under Article 
104(9), on the basis of the Commission recommendation, 
should the two government fail to act in accordance with 
their own commitments."  He went on to declare that the SGP 
"remains of central importance and should be fully 
respected." 
 
Link to Monetary Policy?  All Part of the Whole Ball of Wax 
_____________________________________________ ______________ 
 
¶4.   (SBU) At his December press conference Trichet also 
mentioned that the outlook for price stability is 
conditional on quite a number of assumptions.  Among them he 
cited the usual, e.g. oil prices, exchange rates, and wage 
developments.  He also mentioned "fiscal measures."  This 
lead to a follow up question, on whether the discussion over 
the SGP will have a direct effect on ECB interest rate 
policy.  Trichet replied that they take in all data to make 
such an assessment and they have a "working assumption" that 
the "commitments that were made by the countries concerned 
and the commitments that were made by the qualified majority 
of the Council would be met 100%." 
 
¶5.   (SBU)Some market commentators have speculated that the 
ECB Governing Council might use monetary policy to "punish" 
Finance Ministers for their decision.  ECB officials are 
quick to point out that this is not the case.  Rather, 
fiscal policies are included in the comprehensive array of 
data the ECB examines in determining potential inflationary 
pressures. (Note:  The notion of such retribution is not as 
odd as it may sound; the halls of the Bundesbank still echo 
with the story of the then-Chancellor Schmidt flying to 
Frankfurt to plea for lower interest rates directly with the 
Bundesbank Council, only to have the Council raise rates 
after he left the room - as if to disabuse anyone that they 
were not truly independent.) 
 
Form and Substance:  ECB Focuses on Substance 
_____________________________________________ 
 
¶6.   (SBU) At the press conference one journalist attempted 
to lure Trichet into a debate of the form of Ecofin's 
decision over its substantive meaning, e.g. implications for 
the euro.  Trichet would not take the bait, musing that one 
cannot "separate the form, the procedure and the substance." 
However, the following week at the Economic and Monetary 
Affairs Committee of the European Parliament, Trichet did 
seek to clarify the "economic underpinnings" as to why the 
SGP is "very important for the function of the single 
currency area." 
 
¶7.   (SBU) He explained that the SGP allows him to respond 
to two criticisms, "frequently voiced from the other side of 
the Atlantic."  First, is the criticism about monetary 
policy conducted with "random behavior of fiscal policies" 
in the absence of an EU federal budget.  Second, is the 
criticism that the absence of a federal budget does not 
allow Europe to cope with asymmetric shocks, when one 
country suffers a shock not felt by another.  The SGP is the 
only means by which Europe can claim to deal with random 
fiscal policies and to admonish countries to have a close to 
balanced budget to provide room for maneuver to cope with 
shocks. 
 
¶8.   More generally, Trichet said that there is a limit 
beyond which increased deficits "hamper growth because you 
are creating more lack of confidence than .you can get from 
the simple neo-Keynesian effect."  According to an ECB 
official close to Trichet, this is a very personal view, not 
one necessarily blessed by the Governing Council.  Trichet 
had elaborated that point in his first major policy speech 
on November 20 in Frankfurt.  He had said that governments 
following the SGP "will reduce public spending, which is 
conducive to growth through the alleviation of unproductive 
spending and reduction of costs in the economy."  In his 
view, economic growth would be enhanced since lower deficits 
would diminish medium and long-term interest rates and 
improve households' and business confidence that taxes won't 
increase leading to higher consumption and investment. 
 
Ecofin Decision: Trigger Cocked, but Will Commission Pull 
It? 
_____________________________________________ ____________ 
 
¶9.   (SBU) According to an expert in the EU Council, the 
Council decision reflected the discretion afforded Ministers 
under the SGP, but was firmer than the press or the 
Commission made it out to be, in his opinion.  He shared the 
ECB's view that Ecofin had put itself on the hook to take 
action:  "The Council stands ready to take a decision under 
Article 104(9)"  should France or Germany "fail to act in 
accordance with the commitments set out in these 
Conclusions."  Note that Article 104(9) is the step 
requiring specific commitments to be fulfilled within a 
specific timeframe.  Failing that, the next step would be 
sanctions under Article 104 (11). 
 
¶10.  (SBU) With respect to sanctions, this Council expert 
pointed out that Ecofin's decision to hold the excessive 
deficit procedure in "abeyance" was designed to retain the 
leverage of possible sanctions.  Under Article 7 of Council 
Regulation 1467/97, the decision to impose sanctions "shall 
be taken within 10 months" of the dates from which the 
excessive deficits were reported.  For France that would be 
at the end of December - one reason the Commission rushed it 
treatment for France (reftel).  By putting the procedure 
into "abeyance" (a measure also provided for in the Council 
Regulation), the clock is stopped on the 10 months time 
limit for imposing sanctions.  In practical terms that would 
mean that failure to fulfill these commitments would still 
result in sanctions even though the original 10 months time 
period had lapsed. 
One Observation 
_______________ 
 
¶11.  (SBU) All this is interesting, but the open question is 
whether Ecofin would fulfill its own commitment.  To do so, 
the Commission would have to make another recommendation to 
Ecofin for action should France or Germany be straying from 
their respective consolidation paths.  Having lost this 
round, the Commission may feel shy about a second attempt - 
once bitten, twice shy.  On the other hand, if France and 
Germany are clearly off track, it would be interesting for 
the Commission to call Ecofin's bluff.  If the Commission 
had a strong case, it would be difficult for Ecofin to face 
it down again - particularly with so many other EU economic 
issues, e.g. budget, constitution, at play. 
 
¶12.  (U)This cable coordinated with USEU and Embassy Berlin. 
 
¶13.  (U)POC: James Wallar, Treasury Representative, e-mail 
wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)- 
7535-2238 
 
Bodde