The project of the European Union started in the post-WW2 years with the goal of avoiding future wars between European countries while also promoting economic integration and prosperity. From the Coal and Steel Community to the European Monetary Union, the European project has faced many changes and has not only become an economic union, but also a political and monetary union.
With the creation of the European Monetary Union in 1999 and the introduction of the euro, euro-area countries have given up their monetary policy to the ECB. The Monetary Union has not been as successful as many had hoped for, however, it has survived for the last 20 years. From its creation, it has failed to be an optimal currency area and asymmetric shocks between different countries and regions within the euro area are still very likely.
Therefore, in the EMU fiscal policy remains the only policy instrument that allows countries to deal with the effects of asymmetric shocks. The Stability and Growth Pact (and later the Fiscal Compact) perpetuated the budget and debt criteria of the Maastricht Treaty in order to keep national budget deficits in line with the monetary policy of the ECB. Countries inside the EMU should be aware that their fiscal policy has both internal and external dimensions and should maintain a balanced budget in order to allow for countercyclical macroeconomic policies and to avoid destabilising the rest of the monetary union.
As the monetary union was not created alongside a Banking Union or a Fiscal Union, a lack of respect for budget rules along with weak economic coordination and very different economic structures between countries contributed to very asymmetric responses to the 2008 financial crisis and to a sovereign debt crisis. A new equilibrium between the evils of austerity and moral hazard has to be found.
The low credibility of the SGP encouraged moral hazard problems and general disrespect for budgetary rules that in the end amounted to unsustainable policies, which in turn resulted in near default situations and the bail-out of several countries. Those that mistrust greater economic and political integration argue that a Fiscal Union or the creation of a stabilisation mechanism would favour more moral hazard behaviour that would fuel further sovereign debt crises and consist in a fiscal transfer of funds from those that “comply” with the rules to those that “break” them. This argument, although attractive to many, is far from explaining the “whole picture” as it ignores several key factors.
The high budget deficits in Southern European countries were not just the result of bad economic policies and moral hazard. They also resulted from weaker economic fundamentals and an economic structure that creates less added value and from the clustering of economic activity in North-western European countries. This led to those countries being more vulnerable to the financial crisis, to a downgrading in the country’s government bond ratings, and a subsequent increase in bond yields which led to a rapid deterioration of public deficits and debts.
The European Union was founded on the idea of shared prosperity and of convergence between poorer and richer countries. This was a fact for many years. However, in several countries, in particular from Southern Europe, economic convergence has not occurred since the EMU was introduced. This endangers the sustainability of the monetary union as some countries continuously register lower growth rates and high balance of payments deficits without having the exchange rate as a policy instrument.
It is acceptable to ask countries to follow sound fiscal policies, but it is not acceptable to ask countries to have a much higher degree of economic effort due to factors that are mostly exogenous. It is necessary to find an equilibrium between supporting sustainable fiscal policies and policies that promote long-term economic growth. During the last 20 years, the right balance was not found. The idea of deepening the EMU and making it fairer is already accepted by many decision-making players in Europe (including a roadmap for deepening the EMU by the European Commission).
It is necessary to partly reform European institutions and to create a system that finds a balance between risk-sharing and risk-reduction. I believe that the current framework is still insufficient despite some recent improvement (like moving towards the completion of the Banking Union). The economic cooperation framework that shuns fiscal transfer of funds has not prevented moral hazard or the necessity to bail-out indebted countries and has not improved long-term economic growth perspectives (with an exception to the ECB under Mario Draghi).
Moving towards a fiscal union—more coordinated policies and a stabilisation mechanism—will improve the soundness of economic policies and reduce divergences between countries. It is necessary to create a Eurozone budget, to restructure the European Stability Mechanism (ESM) into a European “IMF” and to reformulate the SGP in a way that it is at the same time more flexible and credible. These measures are paramount so that long-run economic growth is promoted, divergence between countries and regions is counteracted, the necessary economic instruments to face asymmetric risks are available, sustainability of fiscal policies is ensured and a “roadmap” of what to do when a country is close to default is created.
The idea of Eurobonds, i.e the common issuance of debt at a euro-area level, could also be explored. The mutualisation of debt has clear legal challenges and faces the possibility of increasing moral hazard, but it would reduce liquidity risk-premia, lower bowering rates for “crisis countries”, break the “bank-sovereign” loop and provide a sizeable safe asset for financial markets.
Critics of greater economic and fiscal integration defend that it would infringe into a country’s sovereignty and take away their remaining policy instrument available: fiscal policy. However, I’m not advocating (as no one else is) for the “Europeanisation” of national budgets, but for an increased economic and fiscal cooperation and the introduction of a common fiscal capacity to help solve structural problems that are at the core of the EMU. This would actually increase the efficiency of fiscal and monetary policy and in the end be beneficial for poorer and richer, debtor and creditor countries alike while upholding the principle of subsidiarity.
If you go beyond the short-term and think about the long-term, taking more steps towards a fiscal union (but not a complete fiscal union) will rekindle economic convergence and reduce the likelihood of asymmetric crisis and of the accumulation of macroeconomic disequilibria and the subsequent need for a bail-out.
Critics will cry out that the EU is a union of nations and that increased fiscal integration will go against that. But they forget that the EU is a project of nations with a common set of values that have decided that their economic and political fates are intertwined with the idea that unity will make them stronger and more prosperous. If those critics win, they will only create more room for economic uncertainty and feed the growth of damaging populisms.
In my opinion, this is the only road towards improving the soundness of the EMU and of all of those that live within it, if one is honest about defending the continuity of the monetary union. Moving towards greater economic and fiscal cooperation is the only possible way to honour the vision of the European founding fathers and to construct shared prosperity that does not fall into the trap of petty nationalisms and rivalries.