The European Monetary Union (EMU) is the largest and most ambitious monetary union attempted so far. It is a continuous process, whose value derives from the ever-changing, dynamic and often polarising relationships between member states that sustain the circulation of the euro. The EMU presaged a new form of monetary cosmopolitanism in which states and nations were increasingly irrelevant. If the Eurozone resembled a monetary and financial union during its first few years, it turned out to be an illusion. Some Eurozone governments such as Germany with a stronger reputation have enjoyed a lowering of rates, whereas other countries considered weaker – Portugal, Ireland, Italy and Greece (PIIG) – could not draw the same benefits.
Complexity and Uncertainty
Since the beginning of the euro circulation in 2002, trust played an integral part in the maintenance of the social relationships between the Eurozone countries, in the face of two particular conditions: uncertainty and complexity. Trust in the Eurozone fluctuates. This is not only because member states and investors’ expectations regarding the future re-exchangeability of the euro are likely to rise and fall, but also because such expectations cannot always be accurately characterised during periods of high uncertainty. The euro proponents thought that they could solve a host of societal and economic problems, however following Greece’s sizeable budget cuts and tax increases as of 2010, enacted after deep and sustained pressure from the ECB and other Eurozone countries, there are clearly issues with the European Monetary Union.
A Massive Blow Between 2007-2009
Following the outbreak of the recent financial crisis, it became apparent that there is a significant absence of coordination between the monetary and the fiscal spheres. In contrast to the USA and the UK, the European Monetary Union has revealed an underlying weakness, namely the absence of a unitary or federal state in Europe. Given the absence of a real political union, the stability and growth pact have acted as anchors for the euro in the world market. Contrary to the USA, which has been able to relax fiscal policy, the euro has required fiscal tightening as the crisis has unfolded. The implication has been to push member states towards policies that further squeezed workers in peripheral countries, while defending the interests of the European financial system. Thus, monetary union has meant an asymmetric adjustment between banks and states in the financial sphere after the crisis: banks have been protected, while the onus of adjustment has fallen on weaker peripheral countries.
Also, sovereign debt rose rapidly once the crisis had set in. The drop in output led to falling revenue, while expenditure rose chiefly to rescue the financial system. The immediate cause of the sovereign debt crisis is now clear: The Eurozone countries have had to issue enormous amounts of debt at the ‘worse time,’ thus facing increases in yield. Not only banks reduced their lending in 2009 and switched to holding short-term securities, but also avoided bonds in 2009, acutely aware of the rising pressure in financial markets, hence opting to issue equities. Germany has benefited at the expense of peripheral countries, mostly through entrenched current account surpluses that have been translated into capital flows to the rest of the Eurozone. The sovereign debt crisis is the outcome of, first, precarious integration of peripheral countries in the Eurozone and second, the crisis of 2007-9. The public sector in peripheral countries has confronted an increased need for borrowing because it has rescued finance while attempting to forestall deep recession. The problem with the IMF dealing with Greece – and potentially others- is that the Eurozone issues with purports to be an alternative to the dollar as world money. The damage to the standing of the euro as a result of IMF intervention would be palpable.
Reform of the Eurozone
The treaties establishing the euro, for one thing, have expressly forbid providing rescue loans. In this context, the government of peripheral countries have begun to introduce austerity policies in the hope of bringing down borrowing costs in the open markets. The strategy was first adopted by Ireland, but then also by Portugal and Spain, and with increasing alacrity by Greece in early 2010. In effect, peripheral countries were forced to adopt IMF conditionality, without the IMF loan, to persuade bond markets that public finances could be brought under control through the actions of peripheral governments.
- There has been a disjuncture between unitary monetary policy and fragmented fiscal policy. The rules under which the ECB operates have been unnecessarily restrictive, including an exclusive focus on inflation targeting and forbidding the acquisition of public debt. Furthermore, there has been no provision for centralised fiscal transfers that could alleviate some of the tensions created by the single monetary policy.
- There has also been a lack of an established mechanism of fiscal intervention in crises, as it became abundantly clear in 2007-9 when each nation state was left to fend for itself and its domestic economy. The absence of such mechanism became glaring as Greece neared default in 2010.
- There is no prospect of a single European state, hence no prospect of unified fiscal policy. The member states have no power to monetise directly; they have no power to do this independently. The fiction of the euro as homogenous money is at the heart of the current (EMU) crisis. The real answer to the common currency area would be to have a European budget across the Eurozone to support a common currency. But for that to happen, the present institutional and political arrangements of the Eurozone would have to be overturned.
- Radical reforms in the fiscal sphere would probably lead to the failure of the monetary union altogether, as the international role of the euro would come under pressure. However, radical reforms could also lead to the collapse of the European Monetary Union.
The real difficulty of the Eurozone would not be formal arrangements but political relations within the Eurozone. Germany, which would probably bear the primary burden, has gone through sustained austerity for almost two decades. It also has expressly and repeatedly opposed the notion of bailing out states within the Eurozone. There would be significant political costs for any German government in making money available to other states. Furthermore, lending to Greece might open the gates to other peripheral countries. The underlying structural problem of the Eurozone is that German competitiveness has surged ahead during the last decade. Greece and other peripheral countries have not succeeded in raising productivity sufficiently to overcome the pressure that Germany has applied on its workers. Thus, regulation of external capital flow would be required to marshal national resources. Managing capital flows is also necessary to avoid importing instability from abroad, as even the IMF appears to have recognised of late.