The Options for a True Economic and Monetary Union
|By invitation only|
Mon 14.10.2013 at 9:00-11:30
The European Union is in a state of flux. The financial and economic crisis has shaken the foundations of the Economic and Monetary Union (EMU). Several decisions have already been taken to overcome the current crisis and prevent new ones. Further reforms are currently negotiated to reinforce the EMU. What are the main options for EMU's development? What kind of economic and political implications underpin the different pathways to a more stable Economic and Monetary Union?
Opening remarks: "The future scenarios for the EMU”
"Fiscal union and the mutualisation of shocks in the Euro area”
"Why do we need a banking union?”
Chair: Juha Jokela, Director of EU Research Programme, the Finnish Institute of International Affairs
This seminar is organized under the research project "EU after the economic crisis”. The project is evaluating EU's development trends, and their implications for the EU and Finland with an objective to support political decision-making as well as public debate. The project is carried out by the Research Institute of the Finnish Economy (ETLA) and the Finnish Institute of International Affairs (FIIA). It is funded by the Jane and Aatos Erkko Foundation
Summary of the seminar
Institute Director Dr Teija Tiilikainen opened the event by welcoming everyone to the seminar co-organised by FIIA and Etla (Research Institute of the Finnish Economy) and introducing the topic of the day, the EU’s Economic and Monetary Union (EMU) and the current state of processes initiated in the wake of the past economic crisis and, as has been argued according to Dr Tiilikainen, to equip it for future challenges. Dr Tiilikainen also mentioned that the political and economic implications of these measures would be discussed as well as those to the competences between member states and the EU. Some issues of interest would be the scope of the measures and the system of governance.
Dr Tiilikainen said a few words on the background of the seminar, which was part of a two-year project with Etla funded by the Jane and Aatos Erkko Foundation focusing on the future of EMU. The aim of the project is to analyse different future scenarios for the EU and EMU after the past economic crisis, including how such directions would affect EMU and what kind of political implications for Europe and Finland would follow. A key question is whether there will be gradual developments or a more direct change. The project gives an outline of three scenarios: the continuation of the EMU in its current state, a transition to a system based on an enhanced economic and fiscal solidarity such as eurobonds or taxation, with the current institutional framework however remaining essentially the same, or fiscal and constitutional federalism leading to a farther-reaching monetary union and a larger EU budget. The research project is set to conclude by next summer.
Chair of the seminar, Institute Programme Director Dr Juha Jokela gave an overview of the backgrounds of the speakers and gave the floor to the first speaker.
Dr Cinzia Alcidi, Head of the Economic Policy Unit at the Centre for European Policy Studies (CEPS), speaking under the title "Implications of EU governance reforms” began by stating that she would focus on the latest institutional reforms and the fiscal compact with a broad picture. Dr Alcidi wanted to highlight that the reforms take place in the context of a complex pattern and are a result of different developments, not just the crisis of the eurozone. They have implications for both EMU and the EU. Fiscal policy is often seen as the central issue, the major problem that economic coordination seeks to solve. According to Dr Alcidi, however, the external position of countries matter as well: economic coordination is not a universal solution and may not be desirable in certain conditions. Dr Alcidi called into question the effectiveness of the current system which is based on structural balance, a key concept in the application of the new system of governance, the implementation of which, however, is an uncertain indicator and difficult to assess.
Dr Alcidi stated that the basis for the European semester consists of three elements: the Six-pack, the Two-pack and finally the Fiscal Compact, also referred to as Treaty on Stability, Coordination and Governance. The former two are based on an intergovernmental agreement that aims to ensure fiscal discipline, with elements which are directed towards the eurozone but affect the whole Europe. The Fiscal Compact, on the other hand, applies to eurozone member states and those who choose to sign it. What Dr Alcidi wanted to illustrate was that the governance structure here is very complex, and that there is a risk of overlapping competencies. But while there are different actors involved, the common denominator is strengthening fiscal coordination and economic discipline.
Dr Alcidi then moved on to the content of these arrangements: she stressed that the guiding principles may even be unclear. One element is that the major threat to the eurozone is seen as coming from the fiscal side and this message is also sent by the European semester. There is a set of measures looking at the external positions of countries, which have independent importance, and the focus is strongly on the fiscal side. The solution here is fiscal coordination. This leads to a setting where Brussels knows what is best for countries and the Commission takes the role of the guardian of stability in Europe. However, there is an economic rationale for coordination: for example, there are potential spillover effects from decisions made in one country that could affect another country and EMU as a whole. This, however, has to be looked at on a country-by-country basis. While there are good reasons supporting economic coordination, it is not certain if this is always desirable when taking into account country-specific situations and different economic circumstances.
Dr Alcidi pointed out that the Fiscal Compact will enter into force on January 1st2015 and that all member countries except the United Kingdom and Czech Republic will be joining the treaty. Countries will have to include a principle for balanced budget in their constitutional laws with no more that 0.5% deficit adjusted for cycle. However, this requirement for structural balance is hard to observe. Calculation requires the estimation of potential GDP which cannot be observed and isrevised over time – there is an ongoing vivid debate on how to compute the potential GDP. This way, a simple rule may be actually quite hard to enforce. Furthermore, assessing structural reforms is challenging. There is a surveillance arm that assessed the performance on how countries implement structural reforms. It is, however, hard to see whether this should mean the outcomes or the process of implementing certain reforms such as improving the judicial system.
Dr Alcidi summarised her main points. According to her, the governance system is very complex, the guiding principles are hard to identify and while there is a strong emphasis on economic coordination, it is not certain that this is always desirable but rather conditional on the economic situation of countries. A setting should be avoided where Brussels controls countries that know the right course of action better than EMU and when the measures imposed by its perceived "dictatorship” are not even delivering. The effectiveness of the planned system is uncertain.
Mr Francesco Papadia, Affiliate Fellow at Bruegel and Chairman of Primary Collateralised Securities, giving his speech on "Fiscal union and the mutualisation of shocks in the Euro area”, divided his presentation into three parts: what is needed and hoped of the fiscal union; what is the current state of affairs; and what gap remains between the expectations and reality and how to relate to this gap.
According to Mr Papadia, there are two main approaches to fiscal union: either it should be designed to optimise results or, in a more modest set-up, to avoid damages. There are elements of both approaches in the EU legislation, and balancing between the two requires tradeoffs. Mr Papadia raised the question why one should stop short of optimising the results – do citizens not deserve such a system? Problems may nevertheless occur with the difficulty of achieving such goals in the short and medium run. Mr Papadia himself supported a realistic approach where the goal is set to limit damages, and by making this moderate choice, an opportunity for more exact measures arises. In terms of fiscal policy, focus should be on what can reduce risks and negative spillovers. Of vital importance is mutualising idiosyncratic shocks. EMU has been critisised for removing the possibility to use foreign exchange as a means to mutualise shocks while having nothing to substitute for it. Finally, the limited approach aims to provide an ultima ratio, a backstop for the consequences of the banking union.
To answer the question about what is needed from a fiscal union, one must, according to Mr Papadia, first analyse what kind of other systems there are already in place to mutualise shocks. Important examples are financial and credit market integration as well as migration flows. The strength of these systems has transformed: the former has gone down and the latter up. Mr Papadia stated that the overall sense in existing literature leads to a conclusion that both tools are significant but their effect is by no means immense. Before the eurocrisis there were hopes for further integration but there were actually steps backwards during the time of the crisis. Currently the banking union is expected to enhance financial and credit market integration, but it is not there yet and its contribution should not be exaggerated. Migration has not been seen as an important factor within Europe overall; however, migration from outside the EU is significant but not large. Taking into account the limits of these two factors there is still an important role to be played for a fiscal union, Mr Papadia said.
For Mr Papadia, there are two ways to see the fiscal union. One is the disciplining of the national budgets, and the other is to have a federal budget, should expenses like unemployment and revenues like corporate taxes be brought to the federal level. However, before making further judgements, one should be aware of the existence of many intermediate solutions such as jointly guaranteed borrowing which would imply a gradual withdrawal of fiscal sovereignty. Consistency between national and federal levels should be observed, and what is needed is a method to mutualise shocks – a means to support the banking union.
Mr Papadia then raised the question of what there is now in terms of fiscal union. He referred to the complexity of governance as stated by Dr Alcidi. Mr Papadia stated that in fact, there might already be a federal component in the crisis response and gave the European Stability Mechanism as an example which he saw as something between an insurance and burden-sharing. Furthermore, while the eurozone is essentially about monetary policy, the actions taken in the eurozone have mutualised idiosyncratic shocks as a by-product and even facilitated implicit transfers. Mr Papadia asked whether it can even be said that the eurozone has issued common debt in the way it has handled its crisis. While this view may be controversial, the volume of money collected, more than trillion euros at its peak, proves that the funding for the euro system has been very significant.
In the last part of his presentation, Mr Papadia talked about next steps. He said there that there is still an institutional gap in what already exists and what is to be hoped for and that this gap was not filled in a desirable way during the crisis. The question he raised was how to fill the gap with optimal means, within a proper timeframe and following a correct sequence. The union could proceed with increasing control and guidance of national budgets, but according to Mr Papadia, a certain limit has already been reached here. Based on tough experience it can be said that it is ultimately the willingness of countries to comply that matters, and this has not been a great success. And even if this functioned perfectly, the potency is limited.
This is why Mr Papadia saw increases to the federal budget as a reasonable solution. This would not necessarily lead to an addition of public budgets but rather some national budgetary responsibilities could be substituted by the new federal budget. Cyclical expenses such as unemployment expenses and revenues like corporate and real estate tax could be transferred to the federal level. Many measures could be taken with the current institutional framework, but Mr Papadia believed that there would be gradual movement towards mutualisation even if actions such as eurobonds might be morally hazardous and not feasible politically - on the other hand, Europeans have proven to be capable of taking action when this is truly necessary. In his conclusion, Mr Papadia stated that along with the increased federal budget an ultimate federal backstop for balancing the budgets would be a goal worth striving for as well as certain progress towards common issuance.
A question was raised in the audience concerning the cyclical and structural components of the expenses. Mr Papadia observed that unemployment changes must be seen either in absolute or relative terms – relative to the average of the eurozone. When assessing the matter on an absolute level, when the entire area would be in a downturn, there would be lots of expenses and it should be possible to balance the federal budget by means of debt. On a relative basis, on the other hand, an awkward situation might arise where during cyclical unemployment a country with a bad state of unemployment would have to contribute to another country in an even worse situation, while being already under considerable stress. According to Mr Papadia, this kind of choices must be made and difficulties solved.
In his speech, Dr Antti Suvanto, Advisor to the Board at the Bank of Finland, discussed the topic of "Why do we need a banking union?” Quoting the 2012 Euro Area Summit, Dr Suvanto answered this question by affirming that it is imperative to break the vicious circle between banks and sovereigns. Other justifications for a banking union, according to Suvanto, include finding a solution to the financial trilemma, protecting sovereigns from weak sovereigns, protecting banks from weak sovereigns and reducing supervisory forbearance. There are three pillars of the banking union: Single Supervisory Mechanism (SSM), Single Resolution Mechanism (SRM) and harmonized deposit insurance schemes, and some of the related legislation will be enforced in the coming months.
Dr Suvanto then addressed the topic of the single market by going through the history of the Single European Act, the first significant amendment to the Treaty of Rome, which entered into force in 1987 and aimed to complete the single market by 1992. The aim was to promote four freedoms: the free movement of goods, services, capital and people within the European Community. In the 1988 Cecchini Report, the benefits of a single market were recognised by comparing its establishment to a scenario without one. There were high expectations regarding the role of financial markets, including enhanced dynamism not only within the financial sector itself, but also in the markets for goods and services – in the economy overall.
Dr Suvanto underlined that there are three principles in the single market. First, the mutual recognition i.e. freedom to sell services and to establish branches across borders, also referred to as the single passport principle; second, home country supervision meaning that cross-border activities and branches were to be supervised by a home country supervisor; and third, minimum harmonisation which means that regulatory standards were to be harmonised by Community legislation but member states were allowed to impose stricter standards. The aim was to create a level playing field for the competition between financial firms.
Dr Suvanto then moved forward to the process of single currency. With the Maastricht Treaty entering into force in 1994, the objective was to complete the Economic and Monetary Union by 1999 at the latest, which also took place. Integration of financial markets and promoting cross-border banking were not only the cornerstones of the single market but also a prerequisite for a smooth transmission to a single monetary policy. At that time, there were no changes to the foundations of the single market with respect to the financial services. The European Central Bank was allowed by the Treaty to be assigned a supervisory role; some economists saw that there should have been the power to make resolutions as well, so to avoid vulnerability to crises and to what became later called the financial trilemma.
The financial trilemma made known by Dirk Schoenmaker can, according to Dr Suvanto, be described as the difficulty to balance national supervision and resolution, financial integration and the goal of safeguarding financial stability. The trilemma is one of the main justifications for the banking union, because in order to solve the trilemma one has to either re-nationalise the financial markets which would lead to the end of the single market as well as the fundamentals of the single monetary policy or accept the risk of great financial instability or finally, start creating a banking union which implies single supervision and resolution. The latter is what is currently taking place.
According to Dr Suvanto, bank and sovereign risks are tightly interconnected: the causality works both ways. Banks are crucially dependent on the credibility of their home country, comprising elements such as asset quality, ratings and deposit insurance. On the other hand, the home country is responsible for cleaning up the mess caused by a bank failure and this is why there is a need to protect sovereigns from weak banks. As recently demonstrated, the interconnectedness is particularly important for countries belonging to EMU as its institutional design sets tighter constraints on the capacity of the central bank to act as a lender of last resort.
As another issue Dr Suvanto raised the question of national supervision which, according to him, has a tendency of excessive forbearance and delays in interventions. National mandates of the supervisors have led to an inability to handle cross-border challenges and regulatory capture, entailing close relationships between banks and the supervisor, to excessive forbearance on the part of supervisors. According to Dr Suvanto, a comparatively large publicly influenced financial sector in Europe has weakened the credibility of public authorities including supervisors. A properly designed banking union could solve or at least reduce these problems.
What is meant by a banking union, Dr Suvanto then asked. A single rulebook is being developed that applies to all financial actors in the EU. The banking union is based on three pillars: the Single Supervisory Mechanism, the Single Resolution Mechanism and harmonised deposit insurance schemes. The banking union is based on the euro area but other EU countries are welcome to join as well. The Single Supervisory Mechanism, up and running in autumn 2014, will be a unitary supervisory system with the ECB at the centre but working closely with local supervisors due to local information advantage and differing credit cycles. Joint Supervisory Teams will be assigned for each significant banking group with important early intervention powers. A new Supervisory Board will be established with the ECB Governing Council having a veto. The Single Resolution Mechanism aims to complement the limitations of the Bank Recovery and Resolution Directive with a clear and narrow mandate and a comprehensive set of enforceable tools facilitating impartial decision-making focused on the European dimension. The legal basis, the decision-making procedures and the role of the Commission as well as bail-in rules are under hot discussion. Harmonised deposit insurance schemes aim to harmonise national systems and enhance industry responsibility, but a Pan-European Deposit Guarantee Scheme is still in a very early phase. Politically sensitive issues include the mutualisation of national funds. Dr Suvanto noted that as long as the deposit guarantee schemes are predominantly national, a strong channel of contagion remains between the banking sector and the sovereign.
As the conclusion of his speech, Dr Suvanto stressed that when banking supervision, resolution and deposit insurance are properly done, the likelihood of politically loaded and expensive bail-outs of banks is significantly reduced. According to Dr Suvanto, a banking union is needed to protect the internal market, to break the interconnectedness of banks and sovereigns and to reduce supervisory forbearance. Nevertheless, he underscored that the banking union is not a solution to the ongoing crisis: the legacy problems have to be cleaned up first. He stated that the internal market is a common interest for all of the EU, and this is why financial integration remains an important objective for the internal market. According to Dr Suvanto, it is in the interest of all EU countries to participate in the mechanisms. Future steps include balance sheet assessment and stress tests.
Mr Josef Janning, Mercator Fellow at the German Council on Foreign Relations (DGAP) spoke about "Political union” and started by pointing out that what is discussed in the field of European economics does not fly in political terms. What may seem like a federal moment from inside the debate, a window of opportunity to design new processes and institutions, may not look like one at all from the outside. Political discussion is driven by both centrifugal and centripetal forces. The union is pulled together by the magnitude of the crisis but also pulled apart by its implications. The task for the policymaker is to balance these trends. Mr Janning also wanted to remind that there is no one established theory in political science on how to do this. However, something has to be done in order to translate the fiscal or economic rationality into a political structure.
According to Mr Janning, the current situation is burdened by three factors. Political actors share the experience of failed expectations making it hard to move forward. There is also a widespread distrust in the compliance of member states to follow commonly agreed rules. Finally, there is an insufficient leverage or stimulus of fiscal conditionality. The question is, politically, what we need in order to justify and sustain enhanced financial transfers, possibly debt-funded investments into growth and collective debt management. The three elements do not have to be in the same place, but the three speakers made, according to Mr Janning, a differentiated case on whether and how these instruments are needed. In his view, we are back in the Maastricht questions, the challenges of the allocation of powers, institutional efficiency, accountability and legitimacy – and finally, how to politically get into a situation where cooperation between member states would be inspired and enhanced. Political union, unlike EMU, remains rather undefined. This is understandable, as forcing every actor to assume the same definition would only cause unnecessary and hampering disagreements. When it really comes down to the issues, however, this may be a problem. Maastricht was a case in point as many people had different ideas about what a political union or a European Union means: a limited transfer of new power to the EU level or a comprehensive argument not just for fiscal policy but for a more ambitious political union – an example in Maastricht was the case of common foreign and security policy.
In his 3 + 1 agenda, Mr Janning wanted to note that the allocation of powers is all about sovereignty. A political argument that needs to be made is that de facto sovereignty has been lost – in both debtor and creditor countries – requiring a departure of the common rhetoric in the EU affairs. The issue is how to establish co-sovereignty in the fiscal field on the European level. Whether this would mean a veto of an EU finance minister over national budgets or europeanisation of budget decisions, de facto it comes to the same thing: in Germany, it would require changes to the constitution. Should there be either a set ceiling that no country could exceed and which would require binding rules, or a veto, the fact is that sovereignty is lost. For many member states it would mean changes in constitutions. There is no way around a major political debate in all member states.
In all likelihood countries will be trying to avoid this situation by going through backdoor solutions such as rhetorics of necessity and crisis. According to Mr Janning, each of those backdoor solutions will deepen the distance of citizens from the elite. The EU budget is another step: but in light of the distrust argument stated above, to use the EU budget to bypass this situation will not be a viable solution, as the budget is not large enough. However, Mr Janning did not consider it plausible to build new controlling mechanisms for member state economies without a significant increase in the EU budget. A solidarity tax on the EU level, for example, would connect citizens to the matter at hand and a concrete means following the rule of no taxation without representation.
Another point that Mr Janning made was about institutional efficiency. While the European Commission has since Maastricht assumed a number of new responsibilities it has overall become weaker as a body. It has lost much of its non-political credibility and by becoming more political, it has turned into an extended workbench of the European Council. European Council is, on the other hand, very different from what it was in Maastricht and has moved from providing strategic guidelines to giving articulated assignments which the Commission is expected to deliver and report. Mr Janning raised the issue of electing the president of the Commission directly which would give it more freedom of the changing powers in the European Parliament, another way to approach the reform of the Commission, and a mandate to form a meaningful government for the interest of European citizens. The so called second chamber, the Council is according to Mr Janning in disarray and should have been reformed after the Lisbon Treaty. Finally there is the role of the European Parliament requiring many changes to ensure a democratic process like the equality of vote. The Parliament should, according to Mr Janning, be able to connect to citizens and scrutinise the government. The next and probably euroskeptic parliament might actually teach the parlamentarians the lesson of the importance of connecting to citizens. The question is whether any new arrangements for fiscal coordination such as imposed budget ceilings could be democratically monitored by a Parliament where many representatives are not part of the eurozone – this is why there is perhaps a need for a separate democratic governance system for the eurozone. This is part of the problematique on how much power should be given to the Commission.
Finally, there is an issue that the political union must address but which cannot be done by the European institutions. In political terms, Europe needs a governance reform pack. According to Mr Janning, European countries should work together to alleviate the asymmetry in the quality of governance in different countries within the European Union. The idea is to provide the European citizens a claim for high quality governance irrespective of the place of birth or residence. The quality of governance may, in Mr Janning’s view, be one of the key components at the root of the crisis that can be affected by policymakers. Alongside the reform of the union this should become a priority in Europe, Mr Janning concluded.
The audience was then given the opportunity to ask questions. The first was about the challenge to merge a fiscal union, monetary union, banking system and fiscal discipline in a system where some countries belong to the eurozone and some do not. Mr Janning replied by stating that he believed that at some point it would become anachronistic not to want to join the union and that a fully-fledged banking union would require major fiscal actors. He reminded that even the UK and Denmark have signed the EMU and cannot be left out of the table. In order to build something new, an emerging coalition including both north and south and non-euro countries such as Poland and Sweden is needed. Francesco Papadia said that an open attitude is necessary but so is concentrating on the euro area, the core of the European Union according to him. Mr Papadia recognised the difficulty of turning plans into reality because of institutional complexity but on the other hand wanted to underline that the euro area has historically expanded continuously and would probably do so in the future.
Another question was about whether the new government in Berlin will have any appetite for governance reforms. Mr Janning replied that a lot depends on both the coalition setup and key leaders in parties, where there are only a handful of senior actors with the ambition and intellectual capacity to tackle the issues. Angela Merkel’s attitude towards their work is vital here, and her strategy of leading for moderating must change – reforms must be able to be made without an atmosphere of crisis and necessity. Berlin however needs partners such as Paris as well as countries close to Germany: Poland is eager to cooperate with Germany, but Sweden is also important. According to Mr Janning, so to lead, Germany needs as many countries as possible agreeing with its perspective.
The third question was about an alternative plan should the institutional settings discussed above turn out as a failure. Mr Janning saw this as a way of muddling through from one crisis to another. In response to a question on the directly elected president of the Commission, Mr Janning replied that it would help making the role relevant to citizens as opposed to the president of the Council which in Janning’s opinion sends a wrong message about his role. It resembles that of a secretary general, not of a president. He also said that the President of the Commission could serve the Union generally and be subject to parliamentary control – a president elected by the Parliament would instead only rubber-stamp decisions by the Commission. According to Mr Papadia, there is not much to be said about an alternative plan. Many measures have already been used: the only way to go is forward. The ECB should build on its success in monetary policy but will be confronted as a supervisor by a strong push towards forbearance by national supervisors, because big Central European countries will support their national banks. For Dr Alcidi, there is a low probability of success for a fiscal union that pools resources to confront crises and which is seen as a transfer union in Germany. The banking union however becomes more and more necessary for risk-sharing in the private sector, and the US could serve as a benchmark here – this way, market mechanisms could be used for pooling resources in the context of the banking union.
Dr Vesa Vihriälä, Managing Director of the Research Institute of the Finnish Economy, gave the closing remarks. He first noted that the discussion has moved forward from existential questions of whether the euro would survive to actual solutions. The euro area has experienced at least a shaky recovery according to many economists even though unevenly and with existing risks. Now there is a window of opportunity to think about the future. Dr Vihriälä underlined that debt-mutualising and risk-sharing has already taken place through lending and facilities to provide conditional financial assistance, and the ECB has become a guarantor of financial stability in Europe. Significant reforms of European governance have been made that were unimaginable just a few years ago, including the banking union. The question remains whether these reforms have been sufficient. Vihriälä developed the ideas of uncertainties presented by Dr Alcidi and the roles for the banking union described by Dr Suvanto and summarised the question by Mr Papadia of ambition or modesty as well as the discussion of political reforms and the feasibility of different plans by Mr Janning. Dr Vihriälä then thanked the speakers and the audience and closed the seminar.