The years to come will be decisive for the future and stability of the Economic and Monetary Union at the heart of the EU.
The last decade has seen several challenges to the European Union and particularly to the stability of the Euro as a common currency for 19 countries. The 2008 financial crises led to a global recession and afterwards to a sovereign debt crisis. This debt crisis affected the less stable economies in the Eurozone, like Greece and Portugal, and put into question the economic and political feasibility of the Euro, which is far from being an optimal monetary union.
According to the optimal monetary area theory developed by Robert Mundell, a group of countries (or regions) form an optimal monetary/currency area if there are labour and capital mobility, similar economic structures (that result in similar business cycles) and a risk-sharing mechanism that enables a fiscal transfer of funds from more developed to less developed regions. It is clear that the Eurozone does not fulfil most of these conditions: there is low labour mobility, there are very important structural differences in the economies of Euro area countries (especially between Northern and Southern European countries) and there is no mechanism of fiscal transfer between Eurozone countries. However, there is evidence that European economies have become more integrated since the adoption of the Euro, which reduces the likelihood of asymmetric crisis in European countries.
Therefore, when the EMU was created in 1999, the Euro was not given the necessary tools to successfully navigate through a complex and asymmetric crisis, and that political ingenuity was paid heavily after 2008.
Despite poorly-designed bailout programmes and lack of political leadership at the EU-level, the Euro managed to survive, and the EMU is now stronger than before. The development of the Banking Union, with the creation of the Single Supervisory Mechanism and the Single Resolution Mechanism, has improved financial stability and has created the basis for an EU-wide regulatory and supervisory framework at a time when European banks are integrated more than ever. In addition, the creation of the European Stability Mechanism and legislative measures such as the Six-Pack have improved the coordination of fiscal policies among member-states.
A German proposal on the 7th of November has given a fresh impetus towards the creation of a European Deposit Insurance Scheme (EDIS), the so-called third pillar of the Banking Union. Such a scheme would protect deposited sums up to € 100,000 across Europe, regardless of the state of national finances. To ensure the sustainability of this scheme, the German proposal would require a new regulatory treatment for sovereign debt and the harmonisation of national insolvency schemes.
However, much remains to be done in order to guarantee a truly strong European Monetary Union that contributes to economic growth and convergence between member-states, and that is ready to face future asymmetric shocks.
Many countries have called for the creation of a Eurozone budget or some other sort of stabilisation mechanism to protect the Euro area against sudden macroeconomic shocks. However, there has been great resistance to a Eurozone budget from Northern European countries. Those countries have stronger economies and typically register government budget surpluses. The Dutch prime minister, Mark Rutte, even said on 21st June 2019, that he:“would never support more stabilisation mechanisms at eurozone level”. The critics of the proposed mechanism say that its implementation would contribute to a moral hazard problem, in which countries with less stable economies and higher debt levels would not be incentivised to implement the necessary economic reforms and to impose austerity measures.
Above all, I would like to point out the fundamental role of the European Central Bank in guaranteeing the survival of the Euro. In what has become a truly historic moment when, Mario Draghi, in his July 2012 speech, said that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” This signalled to the financial markets the ECB’s commitment to save the euro. This seems to have been enough for markets and made it unnecessary for the ECB to implement its Outright Monetary Transactions programme.
This, in addition to a reduction of key interest rates to a 0% level and the buying of bonds under the Quantitative Easing programme, gave the needed boost to the European economy. By restoring confidence, it incentivised borrowing and reduced government bond yields of peripherical Eurozone countries, thereby reducing the need for austerity measures, and creating conditions for economic recovery of those countries most affected by the sovereign debt crisis.
The last months of 2019 mark the end of the Juncker Commission and the beginning of the von der Leyen Commission and also the transition from Mario Draghi to Christine Lagarde as President of the ECB.
Even before assuming functions, the von der Leyen Commission is already facing important challenges, including the rejection of three of the appointed Commissioners. It is legitimate to doubt whether the new Commission will have the necessary political strength to deliver reforms and to push forward the ambitious policies stated by Ursula von der Leyen. Some of these measures include the implementation of the European Green Deal, the European Common Deposit Scheme and a “Budgetary Instrument for Convergence and Competitiveness for the euro area”. It is possible that political instability, with the growth of Eurosceptic parties in several European countries, may prevent the European Council from approving policies agreed upon by the Commission and the European Parliament.
The last months of Mario Draghi’s tenure in front of the ECB have shown increasing divisiveness between monetary policy decision-makers. Several national bank governors, including Jens Weidmann, president of the Deutsche Bundesbank, disagreed with Draghi’s decision to resume net purchases of assets within the Quantitative Easing (QE) programme. These disagreements along with increased uncertainty regarding economic growth perspectives mean that Lagarde will have a hard time steering the helm of the ECB.
At a time of historically low-interest rates and accommodative monetary policy, the ECB has almost no margin left for further conventional expansionary monetary policy. Therefore, it is questionable whether the ECB has the tools to pull the Euro area out of a potential recession. It will be interesting to see what will Lagarde’s policy lines be and whether new unconventional monetary policy tools will be introduced. Faced with difficulties to boost the European economy it is expected that Lagarde continues Draghi’s calls for a closer fiscal union and greater government spending in countries with high savings rate and budget surpluses, like Germany.
In conclusion, with the election of a new European Commission headed by Ursula von der Leyen and the appointment of the new ECB president Christine Lagarde, a new era for European policy-making begins. Let’s hope that they are up to the challenges of steering the EU in an ever more demanding global stage and of continuing with the reform of the Economic and Monetary Union.