Reform and imbalances in the European Monetary Union ( 375,23 KB )

 

The Greek crisis casts doubt on the European monetary union

  During the second half of the 1980s, the construction of Europe went through what has probably been the most fertile and dynamic period in its history. A favourable economic climate, the successful adoption of the Single European Act (the first great step towards integration since the treaties of the 1950s), the enlargement to the south and the apparent stability of the European Monetary System, combined with Jacques Delors at the helm of the Commission, an enthusiastic supporter of the European project. Delors, former minister of the Economy and Finance in France, guessed that now was the time to take a decisive step forward in integrating Europe, complementing the already almost accomplished internal market with a single currency. This undertaking had already been attempted in the 1970s but was disrupted by the monetary instability of the time. This time it seemed possible and, in Madrid in 1989, the idea was formally accepted by the Council. Thus started the drawing up of the document that became known as the Maastricht Treaty, which would introduce the single currency and which came into force in 1993, albeit after a complicated journey.

  Those drawing up the single currency project were aware of its complexity. Comparable experiences in history were not very encouraging (the Latin Union of 1865, the Scandinavian Monetary Union of 1873, etc.) and suggested that, if it wasn't supported by true political union, the life expectancy of monetary union would not be very long. Academia didn't help much either: Mundell's theory of optimum currency areas revealed that, without labour mobility, with little price and wage flexibility and without a shared fiscal system, the project would run the risk of failure. But the decision was political and a suitable formula had to be found. A new currency was conceived that was provided with the utmost protective mechanisms to guarantee its solidity, a kind of seven commandments of monetary union. These are: a central bank that is federal in nature but totally independent of European governments and institutions; restrictive conditions for joining the monetary union; a monetary policy whose aim would be price stability; strict control of the members' public accounts; a ban on central banks financing governments; a ban on a member state taking on the debt of another member state; and close coordination of national economic policies.

  Armed with this protection, the euro has been successful in its first eleven years of life. Even in the midst of the financial storm, many countries regretted not being part of a currency that was acting as a safe haven against external turmoil and are now working on getting the green light to join. In some respects, the euro area has emerged from the global financial crisis in better shape than the rest of the large economies. Compared with the United States or United Kingdom, its public deficit is much smaller (6%-7% of GDP, compared with double digit figures), its currency has remained relatively strong against the dollar and pound, if we adopt a historical view, and its foreign accounts are more balanced.

  However, the Greek crisis has suddenly disturbed this set-up, raising doubts as to the solidity of the euro's design. Greece has been hit by the crisis like the other member states. But it had previously falsified its public accounts, so that it has finally had to admit an unexpected and huge public deficit (around 13% of GDP) that leaves a public debt in excess of 120% of GDP. A very heavy burden made worse by the mistrust of the financial markets, forcing the Greek government to pay a high premium to finance its profligacy. After a lot of hesitation, the Greek government implemented a series of adjustment measures aimed at sorting out its accounts. But the markets are still wary and the financial situation is critical. Sovereign debt default has become a real possibility.

  Default by a state involved in the single currency was not on the euro's radar. The initial reaction by political leaders was one of solidarity: bailing out a neighbouring country to help them out of a tight spot. But they soon realised that this violated one of the euro's commandments mentioned above. The prose of Maastricht, now reconverted into the Lisbon Treaty, makes this very clear: «A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State» (article 125). Of course, as the saying goes, laws were made to be broken. Someone suggested invoking article 122, which allows the Council to approve financial aid for a member state's central government when it «is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control». But using this provision would clearly contravene the spirit of the Treaty. And there was also the German objection. The German constitution also prohibits the central government from taking on the debt of third parties. Moreover, German public opinion does not like the idea of having to pay for the wastefulness of its southern neighbours. The euro was contaminated by the Greek crisis and fell against the dollar, while other periphery countries, including Spain, were unexpectedly punished. What to do?

  One option was for Greece to call at the door of the International Monetary Fund (IMF). The most fervently pro-Europe sectors were indignant at such a possibility. The European Central Bank and the Bundesbank flatly rejected it. Some economists put forward the idea of a European Monetary Fund, capable of tackling problems like the one in hand. A plausible proposal but there wasn't enough time to set up a new institution to resolve the Greek crisis. Others suggested the possibility or expediency of Greece leaving the euro. Finally, EU leaders, on the eve of the European Council in March, decided to take the middle way and approved giving Greece funding partly from the IMF and partly - mostly - from the member states, in the form of «coordinated bilateral loans», whose payment was to be approved unanimously should Greece request it. In mid-April, and seeing as all the turmoil surrounding the Greek debt had not abated, it was agreed that the member states would give a total of 30 billion euros at an interest rate of around 5%, a high level but lower than the 7% demanded by the markets at that time for Greek debt. Greece has already asked to activate this mechanism.

  In short, European leaders have decided to get around the no bail-out clause with the excuse that these are bilateral loans at a non-discounted interest rate. Leaving Greece to collapse is certainly too risky a solution. And, with the current decision, attacks on the euro and other troubled sovereign debt are expected to be defused. But the crisis has highlighted one of the defects in the conception of the single currency, namely the difficulty of managing monetary union that is not supported by political and fiscal union. The multilateral supervision of economic policy has failed spectacularly and greater strictness is needed when establishing and respecting budgetary discipline. Integrating national budget policies even further is still taboo but it's probably the only way to stop any state from being tempted to take advantage of the cover provided by the euro in order to act negligently or irresponsibly.

  This box was prepared by Joan Elias

  European Unit, "la Caixa" Research Department

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