When EU governments signed the Maastricht treaty in 1992 they made two bold assumptions as to the functioning of EMU – the new economic and monetary union. The first was that the centralisation of monetary policy that moving to a single currency implied would be feasible even when other economic policies were left as national responsibilities subject only to relatively mild fiscal rules for limiting strongly deviant fiscal behaviour. The second was that the Single Market, an active competition policy and the greater transparency associated with a single currency would keep national cost and price trends broadly parallel, so that major changes in competitiveness and the associated current account imbalances would not arise.
These assumptions were a priori neither unreasonable, as is often claimed by those who now find the design of EMU “basically flawed” or “premature”, nor were they dictated solely by the consideration that monetary union alone was all that political concerns about national sovereignty would permit. There were solid economic and political arguments for the design. Spill-overs from monetary policies across borders seemed more disturbing than those of other national economic policies. Fiscal policy would become more effective the firmer the exchange rate, so scope had to be left in the system for national fiscal policies while paying attention to the long-term sustainability of national public finances and preventing the EMU from drifting into a coalition of debtors. The main political argument was that national responsibility for fiscal and other economic policies should not be weakened; in the long run that should remain the foundation for convergence, and would act as a brake on antagonisms between creditor and debtor countries.
These assumptions were gradually undermined over the decade following the euro’s launch in 1999. Some might say that it doesn’t matter whether the original design was flawed or just weakened by naïve assumptions, but it does matter if the original design is judged to deserve another chance once the current crisis has subsided. The EMU framework was fatally weakened by over-ambitious policies to stimulate domestic demand in several member states; these either involved growing public sector deficits or booms in construction financed by very rapid credit expansion. In either case, severe imbalances arose between domestic demand and production. The fiscal rules were neither respected nor monitored by partner countries, and the signs of weakening competitiveness and growing external imbalances were not watched. Financial market participants also failed completely in their monitoring role by pushing convergence of interest rates on sovereign bonds in the EMU very far as late as 2009. Only that year’s sharp downturn and the emergence of a massive and initially under-reported Greek fiscal crisis put an end to the amazingly happy co-existence in the EMU of divergent performances and policies.
Since early 2010, the EMU governments and the Commission have been engaged in a double-purpose strategy to restore confidence through minimising the future risk of similar failures and helping to resolve the current crisis. Both steps are needed to restore confidence in EMU participants’ ability to manage the system they had created and to assure the survival of the European project. In fact, much has now been achieved to reduce the risk of future crises: an extension of the rules beyond the strong focus on public finances, an earlier start to the annual review of national budgets (the “European Semester”), a more precise formulation of how to approach the norm for the public debt ratio – all incorporated into secondary legislation in 2011 – and the so-called Fiscal Compact, currently in the process of ratification, to anchor the fiscal rule of balanced budgets in national legislation. These longer-term efforts haven’t really received the credit they deserve. Levels of mutual trust have fallen so low that many critics believe no agreement is likely to stick, while others claim that the only key to restoring confidence lies in the second part of the agenda – a determined exit from the current crisis. It’s worth dealing with these two objections in turn.
Why should rules that were largely unobserved prior to the crisis suddenly work? One reason for optimism is that the rules are now better articulated and can more readily be implemented. A second and more powerful reason is that the evidence on the alternatives to prudent management is so vivid. Whether that alternative is to have to ask for a programme with the European institutions along with the IMF, or to be exposed to major doubts in the financial markets as to the quality of sovereign debt, the perception that a “bail-out” at modest cost by one’s partners would be an option has effectively been dispelled.
These arguments have in themselves clearly proved insufficient to restore confidence. Unless there is an EMU left to save, robust future rules will not impress anybody. In addressing the challenges of crisis management, the second of their tasks, policymakers have been less convincing than in their first, even though here too they have moved well beyond what could have been anticipated by setting up an institutional framework of safety nets with strict conditionality and by establishing intensive co-operation with the IMF on surveillance. The urgency is much greater than in the design of a future system, and the gap between the time horizon of impatient market participants and the needs of 17 eurozone governments that all have to contend with increasingly sceptical electorates has proved extremely hard to bridge.
This tension is aggravated by the need to move beyond current treaty provisions for most of the crisis resolution steps under discussion, while better prevention of future crises has proved manageable inside or outside the treaty. In a note preparing the June 2012 European Council, its president Herman van Rompuy wrote of four major steps towards a European Union in banking, fiscal management, competitiveness, and political cohesion and legitimacy. The first two will at very least require a treaty revision, and German Chancellor Angela Merkel has mentioned this coming December’s European Council as the time to launch the Convention needed to prepare these revisions.
It should boost confidence around Europe that the EU’s largest member state does not shy away from a statement of this kind. But at best it will take several years to agree on new proposals, with the prospects for ratification uncertain in some countries and clearly negative in others and not just the United Kingdom. The likelihood of prolonged political uncertainty will undermine the confidence being generated by the ambitious proposals now emerging. The fact that they are so ambitious must also raise doubts as to the adequacy of the longer-term crisis prevention steps already agreed.
The situation as it now stands presents European integration with a particularly acute dilemma; should the crisis be used as the opportunity to push ahead towards much deeper political integration and greater transfers of national sovereignty to the European level, or should the original Maastricht design with its near-exclusive national responsibilities for economic policy other than monetary be retained, with the remedies for the crisis presented as exceptional and temporary? This second option would imply a strict time limit for crisis management measures. Ensuring that some of the more radical ideas for reforming EMU governance have only a short life span could facilitate their adoption, and would probably shorten the span of political uncertainty that treaty revisions provoke. The best illustration of this is provided by the two areas that have figured prominently in recent reform debates – banking and financial supervision in a “banking union”, and more joint fiscal responsibilities in a “fiscal union”. They are, of course, the first two priorities on van Rompuy’s list.
A full-scale banking union would mean creating a European banking supervisor in charge, at very least, of large cross-border institutions, a common resolution framework for failing institutions and a common deposit insurance system. These wide-ranging proposals reflect the way that bank rescues in some countries, most recently in Spain, have not seemed to be handled safely by national authorities, and that European safety nets would have to be involved. Spain’s bail-out was made conditional on supervisory powers being vested in the European Central Bank (ECB), but it remains unclear whether that is going to make supervision more effective, particularly in the short term, and how the ECB will be able to take on supervisory tasks in relation to individual institutions without running into conflicts of interest with its monetary policy role.
A common deposit insurance system may be desirable in the very long term, but it would inject massive risks into government finances, particularly at a time when some national schemes have been depleted. The co-ordination of such schemes has improved, and could yet be pushed further still.
The one area where a larger European element may be easiest to justify is establishing common principles of resolution, and engaging national public finances but with a stronger commonality. If it proves impossible to agree on treaty change that would permit European-level decisions in this area, which may well be the case because the UK seems very unlikely to agree to it, the same approach as for the Fiscal Compact with an inter-governmental agreement suggests itself.
Shifting the ultimate competence for some fiscal policy decisions from the national to the EMU level is going to need significant and therefore controversial treaty changes. The issuing of joint debt – “Eurobonds” – implies a decisive role for the EMU political authorities, so it is logical to link such issues to treaty change. But there are models for bonds of this type that limit their role in time and scope. Some of these focus on short-term debt and the automatic expiry of the provisions between two and four years, while the debt redemption proposal made by Germany’s Council of Economic Experts assigns part of a debtor country’s revenues to a longer term reduction of debt beyond a norm in return for a joint refinancing with its partners. These proposals deal with the accumulated stock of debt, not with responsibility for the flow of new debt, which is explicitly barred in the treaty. That being said, their structure reduces the risk of moral hazard and offers an opportunity to proceed more pragmatically yet still efficiently towards resolving the present crisis without all the lengthy uncertainties that are inevitably linked to full-scale EU treaty revisions.
Niels Thygesen is professor emeritus of economics at the University of Copenhagen, and a former academic member of the Delors Committee on Economic and Monetary Union email@example.com