During the summer 2011 crisis, financial markets increased their risk perception with regard to the public debt of indebted euro member states in a context of a low economic growth potential. As a consequence they have shown their distrust in the long term sustainability of the European Monetary Union (EMU) in its current framework. European cross-border banks are suffering most from these increased risks. In fact, they hold European government bonds because of regulatory incentives; their business model is based on European economic integration.
Until recently the serious shortcomings of the monetary union were hidden by a relatively easier economic environment. To work properly, the countries of a monetary union should be sufficiently flexible to correct differences in the underlying economies (ie labour migration, nominal wage adjustments, price adjustments) and at the same time there should be mechanisms to ensure that imbalances are promptly corrected. Today, with such a severe crisis, it is inevitable that the shortcomings of the EMU emerge with all their serious implications, exacerbating the tensions in the financial markets, especially for the more indebted economies.
Inevitably, as shortcomings emerge in all their gravity, arguments about the break-up of the euro crowd in. These arguments have a popular and political grip, but they are totally ill-founded: from a legal as well as from an economic perspective the choice to leave the euro is simply not an option. This is true for the weaker as well as the stronger economies of the eurozone. Hence, the real question to address is how to make the euro ‘work well’ in the interest of the all the member states. From a more important political perspective, the single currency, as often repeated also by the euro’s founding fathers, should be seen as a tool and a step to further integration progressing toward an ever closer European Union.
Current measures adopted at the EU level are remarkable and in the right direction, but not sufficient to restore confidence because they are perceived as temporary and inadequate. Other measures to address the short-term risks may be necessary, but they will not restore market confidence on medium- and long-term perspectives.
To restore confidence, the solution is a rapid and credible political agreement among member states on a road map to anchor the medium- and long-term financial markets’ expectations. The recent EU summit has asked the President of the European Council, in close collaboration with the President of the Commission and the President of the Eurogroup, to identify possible steps to strengthen the economic union to make it commensurate with the monetary union. The focus will be on further strengthening economic convergence within the euro area, improving fiscal discipline and deepening economic union, including exploring the possibility of limited Treaty changes. An interim report will be presented in December 2011 so as to agree on first orientations. It will include a roadmap on how to proceed in full respect of the prerogatives of the institutions. A report on how to implement the agree measures will be finalised by March 2012.
The political agreement must be credible, especially concerning the will of member states to adjust the EU/euro area economic governance to a more ambitious pooling of fiscal sovereignty, to safeguard the euro and therefore the EU itself in the long term. The political agreement should include: the procedures for an effective functioning of the agree European economic governance, as well as ensuring budgetary discipline; the sustainability reforms that have to be fully implemented by member states to achieve a structural fiscal balance and higher potential growth at each country level, thereby creating the necessary conditions to ‘put each house in order’; and the definition of a comprehensive toolkit at the EU level for systemic crisis management.
The road map should list the necessary treaty changes and timeline for their endorsement. It could be based on three stages: In the first stage, the role of the European Banking Authority (EBA) and the European Stability Fund (EFSF) should be immediately enhanced in order to effectively manage the present crisis at the EU level. No that European banks have been required to hold more capital to avoid a solvency crisis, the focus should be on the more important aim of providing term funding and exiting from the liquidity crisis. The second stage requires the adoption and enforcement of sustainability reforms, which also imply some constitutional changes, leading to fiscal consolidation and unbinding the growth potential by each member state. The third stage involves allocation to EU institutions of powers and responsibilities for systemic crisis management (including appropriate financial instruments) also when impinging on national fiscal responsibilities.
This is not very different from what financier George Soros has proposed as a long term solution. However, the set up of a common fiscal policy and appropriate institutions for systemic crisis management should also go together with a progressive increase of the European Parliament’s power in fiscal decisions. In the current framework, national governments – elected by national voters – have difficulties in assuming their European responsibilities when dealing with unelected European institutions. With a stronger ‘democratic mandate’ from the EU citizens, the ‘democratic deficit’ in Europe could be reduced.
Besides the emergency financial tools necessary in the short term to manage the EMU crisis, what is really needed is a new political commitment of the main European countries to set up a more integrated political framework.
This article first appeared in Longitude
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