Hal Scott
Bio
Hal S. Scott is the Nomura Professor and Director of the Program on International Financial Systems at
Harvard Law School, where he has taught since 1975. He teaches courses on Banking Regulation,
Securities Regulation, International Finance and the Payment System. During the 2004-2005 academic
year, he is a Visiting Professor at the Woodrow Wilson School at Princeton University.
He has a B.A. from Princeton University (Woodrow Wilson School, 1965), an M.A. from Stanford
University in Political Science (1967), and a J.D. from the University of Chicago Law School (1972). He is
been admitted to practice in Massachusetts and various federal courts.
The Program on International Financial Systems engages in a variety of research. It is currently
completing a study of worldwide capital adequacy rules for banks, insurance companies and securities
firms. The Program also organizes the annual invitation-only U.S.- Japan and U.S.- Europe, and U.S.China Symposia on Building the Financial System of the 21st Century, attended by financial system
leaders in the three countries. The Program also directs a concentration in International Finance for LLM
students at Harvard Law School.
Professor Scott=s books include the law school textbook International Finance: Transactions, Policy and
Regulation (11th ed. Foundation Press 2004) and International Finance: Policy and Regulation (Sweet &
Maxwell 2004).
He is the editor and a contributor to Capital Adequacy Beyond Basel: Banking,
Securities and Insurance (Oxford University Press, forthcoming 2004). He is also an author and editor of
Asian Money Markets (Oxford 1995). His recent articles include A Bankruptcy Procedure for Sovereign
Debtors?, 37 The International Lawyer 103 (2003) and Internationalization of Primary Public Securities
Markets Revisited, in Capital Markets in the Age of the Euro: Cross-Border Transactions, Listed
Companies and Regulation, eds. K Hopt, E. Wymeersch and G. Ferrarini (Kluwer 2002).
Professor Scott is a Governor of the American Stock Exchange and a member of the Shadow Financial
Regulatory Committee. He has served as a consultant to a variety of financial institutions, multilaterals
and governments.
Memo
Statement on Money and Finance
I have been asked to identify issues in the area of money and finance that could affect the future stability
of the European Union. While there are many important developments in the EU in this field, including
new efforts to achieve a single financial market, there is only one area that raises issues that could affect
the stability of the EU, and that is the future viability of the European Monetary Union, and its single
currency the Euro. While Martin Feldstein may have greatly exaggerated matters in predicting that the
failure of the Euro could lead to war in Europe, there is little doubt that the failure of the Euro would create
major instability in the EU, and there is a substantial possibility that such instability could lead to the end
of the EU itself.
The Euro is a young currency, only having come into full force in 2002. Dissolutions of and exits from
currency unions are common. Reuven Glick and Andrew Rose found that from 1948-1997 there were
130 switches out of but only 16 switches into currency unions. 1 These findings present no basis for
predicting the failure of EMU, but do suggest that the possibility must be taken seriously.
1
Does a Currency Union Affect Trade? The Time-Series Evidence, 46 European Economic
Review 1125 (2002).
The architects of EMU recognized that there was a danger in constructing a monetary union, with a single
monetary policy conducted by European Central Bank (ECB), along side separate fiscal policies
conducted by individual Member States. Part of the concern was that irresponsible fiscal policies in
particular Member States might create inflationary pressures that would lead the ECB to raise interest
rates. Responsible fiscal states would then be forced to bear the higher interest rate costs created by the
profligate states. This concern led the architects to impose deficit limitations on countries entering into
EMU, and to impose ongoing deficit constraints under the Stability and Growth Pact of 1996 (the Pact). A
recent study finds that a large inflation differential between currency union members is consistently
associated with a high likelihood of currency union dissolution. 2
2
Volker Nitsch, Have a Break, Have a....National Currency: When Do Monetary Unions Fall
Apart?, CESifo Working Paper No. 113 (January 2004).
3
Under the Pact, any EMU country that runs a fiscal deficit greater than 3 percent of GDP for longer than
10 months has to make a a non-interest bearing deposit with the European Commission. If a country
does not remedy the problem within two years, the offending country may have to pay a fine (if voted by
two-thirds of the EMU members of the European Council) of at least 0.2 percent of GDP. A country can
exceed the 3 percent limit if the excess is “exceptional,” i.e. a result of unusual events outside of control
of the Member State and temporary (forecasts indicate the deficit will fall below 3 percent once the
exceptional situation passes). While a country with a decline in GDP of over 2 percent within the past
four quarters is exempted from the penalties, such persistent and large deficits are uncommon.
The Pact’s constraints have been criticized on the grounds that they impose too rigid constraints on
countries wishing to use deficit financing to stimulate economic growth and that adherence to the
constraints by a country could cause a political reaction within that country that could undermine the
survivability of EMU. Various alternative suggestions have been put forward by scholars, ranging from
relaxing the deficit constraints, to fiscal integration, to selling deficit permits. I have seen no suggestion
that no EU constraints on deficits are necessary.
Several countries, including France and Germany, have exceeded the 3 percent deficit limit. Indeed,
France and Germany are expected to break the Pact’s deficit for a third successive year in 2004. These
countries have resisted EU Commission pressures to lower their deficits. In November 2003, the EU
finance ministers at the urging of France and Germany, voted to suspend the enforcement of the Pact
over the objection of the Commission. In July 2004, the European Court of Justice ruled that the finance
ministers had acted illegally, but the Court also stated that it was up to Ecofin as to whether to impose
sanctions–which it is unlikely to do given the position of France and Germany.
In September 2004, the Commission proposed a rather vague relaxation of the deficit limitations. The
basic idea seems to be that a breach of the 3% limit would not trigger automatic sanctions, but rather the
need for a country plan to remedy the deficit. The pace of adjustment could differ across countries, and
there would be an increased focus on debt levels rather than deficits. Further, the definition of
“exceptional” circumstances could be broadened. These proposals have been criticized by the
Bundesbank but the European Central Bank has yet to take any position. France and Germany have
criticized the proposals as not relaxing fiscal constraints enough.
The deficit issue also affects the speed at which the 10 new member states can join the EMU, since new
entrants must meet convergence criteria, including a 3% deficit limit. It appears several of them do not.
The President of the ECB, Jean-Claude Trichet, recently stated that it was "absolutely obvious" that a
lack of fiscal discipline among the current 12 members of the euro area set a bad example for the 10
countries who joined the EU in May.
4
As I see it, there is no possibility of returning to hard constraints on deficits, and little hope of any
meaningful constraints. Fiscal integration is not a medium term possibility. This then raises the question
as to whether a monetary union can function without any real fiscal constraints on members.
One further point. EMU continues to function without the participation of the United Kingdom and there is
little prospect that the UK will join in the near term. The decision has been constantly put off into the
future. This raises the issue of whether the EU can continue to function on two tracks, some countries
with the Euro and others, including a country as important as the U.K, without the Euro.