June 19, 2017    5 minute read

The European Monetary Union Experiment Pushed to Its Limits

Binding the Union Closer    June 19, 2017    5 minute read

The European Monetary Union Experiment Pushed to Its Limits

Among Economic and Monetary Union leaders, there is a strong tendency to deepen integration and create new mechanisms for coordinating economic and social policies in the euro area.

We see these tendencies in the document “Reflection Paper on the Deepening of the Economic and Monetary Union” prepared by two Commissioners of the European Commission – Valdis Dombrovskis and Pierre Moscovici. It is a continuation of the March 2008 White Paper “Future of Europe,” prepared by Jean-Claude Juncker and the June 2015 report on the “Completing Europe’s Economic and Monetary Union”.

Euro Without Coercion

It is unlikely that all countries will be made to embrace the common currency for several reasons. Firstly, the European Commission has no legal tools to force non-euro countries to switch into the euro, and such action would be contrary to EU treaties and practices. Secondly, this would mean that the EC assumes responsibility for possible crises caused by the adoption of the euro in countries that are unprepared for it.

The European Commission also believes that countries outside the euro area are interested in the future of EMU, and the key issue is who will decide on this issue – all EU countries or only EMU members. Sweden announced that it would enter the eurozone by 2025. Bulgaria, whose currency has long been linked to the euro (similarly to the currencies of Lithuania, Latvia and Estonia), can also enter Bulgaria without any major problems. Almost all non-euro area countries meet convergence criteria, except for ERM II.

Europe of Two Speeds

We can list the three weaknesses of the current architecture of the Economic and Monetary Union. First of all, it is still unable to reduce the social and economic disparities between Member States. Secondly, there are centrifugal forces with a strong political influence that weaken the support of EU citizens for integration, and if the problems of EU citizens are not resolved, then the risk will hinder integration. Thirdly, while the Economic and Monetary Union is stronger today than it was a few years ago, it is still not resilient to shocks and must therefore be reformed.

Financial Union

The elements of a proposed financial union would be the following:

Firstly, a capital strengthening of banks and reduction of non-performing loans.

Secondly, a completion of the construction of the Banking Union. Commissioners consider support from the euro area budgets for the Single Resolution Fund (SRF) and the European Deposit Insurance Scheme (EDIS). They are necessary so that a possible banking crisis does not trigger a crisis of public finances.

Thirdly, the creation of a Union of Capital Markets (CMU). The aim is to create the largest financial center in the euro area capable of financing, among other things, innovative projects of higher risk. It is necessary to create integrated supervision of financial markets and to create common rules for the functioning of these markets within EMU. It is also necessary to cooperate with all stakeholders, including investors, corporations and supervisors. Solutions such as uniform taxation and uniform bankruptcy procedures remain unresolved.

Finally, the introduction of new financial instruments. The authors of the report discuss the proposal to issue sovereign bond backed securities (SBBSs) – securities secured by a diversified portfolio of euro area government bonds.

European Safe Assets: Euro Area Treasury Bonds

The euro area economy is equal to the US economy and both financial markets are comparable in size. But the euro area does not issue bonds such as the US Treasuries Bonds, which are considered the safest securities in the world (whether or not that is actually the case is up for debate). In EMU, individual countries issue their own bonds whose risks are different, although financial markets do not always adequately value them. According to international banking regulations, investing in government bonds is not risky, so commercial banks often have very large exposure to these government debt securities. The experience of the financial crisis has shown that the risks associated with government bonds are often high. Hence the proposal to create euro area bonds that would strengthen the banking sector.

However, their emissions would mean “debt sharing”, which is unevenly distributed inside the euro area. Germany is constantly protesting against such a proposal.

The Treasury of the Euro Area

The most important institution integrating the euro area could be the Treasury of the Eurogroup. It is admitted that the idea of creating it is not specified, but it could be built from funds already existing within the euro area, such as the European Stability Mechanism, and those that will gradually be created. The lack of a precise plan for creating such a budget is a bit of a surprise. In April, Dombrovskis announced that by the end of May the concept of a separate euro area budget would be presented. It is stated in the document “Reflection Paper on the Deepening of the Economic and Monetary Union” that the current budget of the European Union is too small to be a counter-cyclical policy instrument, but the idea of a separate budget for the euro area is just a general outline.

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