By Niels Thygesen
As financial markets and the public debate focus on very rapid debt accumulation by European governments, and by Greece in particular, many people have looked again at the unique construction of Europe’s Economic and Monetary Union.
EMU centralised monetary authority for its currently 16 participants, while leaving budgetary and other economic policies (largely) in national hands. Such a lopsided construction was seen at the start as unlikely to survive without political union, says Otmar Issing, the ECB’s first chief economist – though it is unclear what is meant by “political union”.
Some critics say that it was a mistake to start an incomplete EMU. Others propose wide-ranging institutional extensions in the shape of a European Monetary Fund to handle crisis management. The original vision for EMU deserves some defence — and implementation.
The founders of EMU were aware of the special nature of the project. They set it up as work in progress, before a final deadline in 1999, because it was the best that could be done at the time. By putting the one policy area with maximum spill-over effects across borders into a joint framework, it dealt definitively with the distractions of exchange-rate instability which had dominated the European policy agenda.
More importantly, it was seen to represent a combination of the politically feasible with the economically adequate. There was no political backing 20 years ago for centralisation of authority over taxation and public expenditures or for intergovernmental transfers, nor is there any such backing today.
But nor was such authority seen as a necessary complement to a single currency. The latter was to be underpinned by two elements: exposure to a deeply integrated market for goods and services and a tough competition regime would keep national price and cost trends broadly in line, and fiscal rules, common for all, would constrain individual, strongly deviant budgetary behaviour.
The fiscal rules, which became the stability and growth pact, are elements in a political union with solidarity, having evolved into an annual negotiation framework which is internationally unique. The original vision for EMU was that this set-up would help to assure a good policy mix with, on average, low and hence growth-friendly interest rates, coupled with a prudent aggregate of national budgetary policies. Indirect coordination was chosen in view of both political realities and economic arguments rather than the more direct coordination advocated by some under the heading of “economic government”.
The implementation of the fiscal rules was gradually eroded during the long upswing prior to the crisis, in part by the unwillingness of the two largest member states to see the rules applied to their own policies around 2003.
Recent events confirm the judgment made when preparing for EMU: market forces are excessively tolerant for a long time of sovereign credit risk, but they may change perspective brutally. They have returned with a vengeance, but discipline based on a combination of market forces and policy norms should be welcomed rather than scorned, even though it will be difficult to manage.
There are signs that the combination has worked. If the impressive Greek adjustment programme is seen by the eurogroup and by nervous financial markets as sufficient to make direct participation by other EMU governments in the refinancing of Greek debt superfluous, the original model with national budgetary sovereignty – though more intensively monitored than in the past – has survived for now. Survival is likely to be tested repeatedly, making EMU choose ultimately between two undesirable outcomes: either a default or a bail-out.
The idea that an EMU country could default on its public debt will strike many as outrageous, yet it may have to be faced. No international framework offers a guarantee against sovereign default. International Monetary Fund conditional lending – proposed by some for EMU debtors – does not either, as several examples testify, and as was recognized by the IMF in 2002 when it designed a sovereign debt restructuring mechanism.
The principles of such a mechanism could usefully be studied by EMU countries to assure that default and restructuring are orderly and entail the least possible costs for the debtor and its creditors, including the eventual return of the debtor to international capital markets. While a default could sour political relations, it would be consistent with continued participation in EMU; indeed, renewed access to borrowing will be easier with the euro than without it. Planning for the eventuality of default is also consistent with the emphasis on national responsibility in budgetary policy inherent in the original vision of EMU.
A bailout is a more radical departure. If a package of financing were to be made available from individual other EMU participating governments, or from a new European Debt Agency or Monetary Fund , the intrusion into the debtor’s budgetary policies would become far stronger than just guidelines for consolidation. It could become more of a “hands-on” political union than the creditors have a taste for – their electorates will insist on it – not to speak of the preferences of the debtor. The risk of tensions and mutual recriminations will be particularly severe, if the creditors are individually identifiable and unlikely to agree on the severity of the conditionality to be observed.
This road leads towards more political union and of a more risky and confrontational type. Agreeing a financing package on an improvised basis may entail longer-term costs that must be carefully evaluated against perceived short-term gains. It would seem safer to implement more fully the original vision of EMU with its “arms-length” approach to national budgetary policy, but reinforced by the perception that default is a risk that cannot be excluded.
Niels Thygesen is professor emeritus of economics at the University of Copenhagen. He was an independent member of the committee for economic and monetary union in Europe, chaired by Jacques Delors in 1988-1989.
Related reading:
The euro will face greater tests than Greece George Soros in the FT
Some benefits and costs from participating in a monetary union Francesco Paolo Mongelli, Vox
