Euro rules row bodes ill for Europe's future

The rules that govern the euro - known as the Stability and Growth Pact (SGP) - were established in 1997 mainly at the request of Germany.

The idea was that debts would have to be controlled in a currency union. If there were no rules, then countries might feel free to run up higher debts in the knowledge that they would be bailed out by other countries in the euro zone.

The Stability Pact set out to stop this by imposing a limit on how much countries could borrow. It was decided to limit budget deficits to three percent of GDP each year and an elaborate procedure was set up to punish those countries that broke the rules.

It is this punishment procedure that was effectively shelved this week, leading many economists to suggest that budgetary discipline in the euro zone is now dead. If France and Germany don't have to play by the rules, why should other countries?

This idea - of relaxing this budgetary discipline - has far-reaching economic consequences and the idea of member states being unable to agree on such crucial economic rules has critical political significance.

Economic consequences

What does potentially greater fiscal indiscipline in the euro zone mean for the European in the street?

In the short-term, maybe higher interest rates. The European Central Bank has warned in the past that failing to respect budgetary discipline could fuel inflation, which in turn could lead to higher interest rates.

Although the row in Brussels may seem far away, it could affect your mortgage repayments - if you live in the euro zone.

But it's not necessarily all bad news, economically-speaking.

Many analysts actually think that the recent disagreements are good news for the euro zone's economy.

They argue that making Germany and France - which between them account for almost half of the euro zone's economic wealth - raise taxes or cut public spending will stifle growth in these two countries and therefore harm growth in the whole zone.

Relaxing the rules, some say, will free them to grow and provide a much-needed spurt for the whole European economy.

Political consequences

But the political significance of the feud may have a greater impact on the EU - and future EU - as a whole.

First, countries that are currently outside the euro - Denmark, the UK and Sweden - will look at the chaos surrounding the rules and the club and, in all probability, decide to stay out for the foreseeable future.

And for those - mainly smaller countries - inside the euro who tried hard to stick to the rules, sometimes with painful tax hikes, the shackles have been removed.

Countries such as the Netherlands may feel that if Germany and France break the rules, then why should they not? The row may provoke a round of tax cutting and public spending, further increasing the deficit of the zone as a whole.

Second, the accession countries will look at the euro with new eyes. All ten new EU member states are bound by the terms of their accession treaty to join the euro, but they must first adhere to strict criteria, including the criterion that their deficit must be below three percent.

It was expected that these countries would have to take painful measures to adhere to these rules, but they may now feel less bound by them. If Germany can be in the euro with a deficit of four percent of GDP, Poland may well say, why can't we?

Constitution in peril

But the main political danger must be for the Constitution and the intergovernmental conference (IGC) which is thrashing out the EU's future.

The row over the Stability Pact has been presented as a row between small countries and large countries. The Netherlands and Austria, in particular, argued that the rules should be kept as they are whereas France, Germany and the UK wanted them relaxed.

Similar fault lines exist in the negotiations over the new Constitution. On issues such as the make-up of the Commission or voting weights in the Council, it tends to be big versus small.

Having lost this battle, the smaller countries may be in less of a mood to compromise on these and other crucial issues, making agreement even harder to reach.