Once again, after a painful learning process and motivated by the best of intentions, European leaders gather in crisis management mode. Important decisions are taken but, again, they appear to fall short of the dramatic breakthrough required to get ahead of a crisis that eats away at the integrity of the region’s historic integration project.
To be clear, there are encouraging signs. First, leaders have recognised the need to identify longer-term reforms that, in addition to addressing the eurozone’s initial design flaws, provide a solid basis for effective short-term stabilisation measures. Second, they wish to improve the functioning of regional firewalls (such as the European Stability Mechanism). Third, this will be used as the context to enable individual countries to strike a better domestic policy balance – including by acting both on the numerator of medium-term sustainability (debt levels and debt service payments) and, critically, on the denominator (actual and potential economic growth).
Progress is not limited to the sequencing and coverage of policy steps. The substance is also more constructive.
Leaders now understand that, especially in the aftermath of the global financial crisis, the eurozone cannot survive on the basis of monetary union alone. It also urgently needs greater fiscal, banking and political integration. They are taking steps to break the disruptive “feedback loop” between weak banks and deteriorating sovereign creditworthiness. And they recognise that, to succeed, all this should be supported by growth-enhancing policies.
This good news exceeds the low consensus expectations in the run-up to the summit. So, initial market reaction will be favourable, especially given end-of-quarter positioning. But, without a dramatic breakthrough, it won’t be long before people worry that, once again, European leaders are not keeping pace with the crisis, let alone get ahead of it.
Signals out of the Brussels summit suggest that the implementation timetable remains too leisurely, especially in light of the increasingly complicated and disruptive conditions on the ground. The concept of a “roadmap” for fiscal union and a single European bank supervisor by the end of 2012 lacks sufficient details and precommitment. Firewalls are too small, do not have robust funding lines and are operationally complex. Countries still disagree about the right balance between financing and reform.
Not surprisingly, some officials are already adopting different narratives. Witness the comments from Finland, Germany and Italy. Also interestingly, creditors and debtors each seem confident that they can continue to play a game of chicken with the other side.
This is but one illustration of the political complications that accentuate economic and financial shortfalls. Having previously failed to inform citizens fully of the gravity of the situation, leaders find it hard to command the domestic political consensus needed for a sustainable regional solution. National agendas do not easily translate back and forth into regional ones; and the lack of credible mutual assurances complicate matters further.
So, once again, a European summit could well disappoint. Should this happen, the consequence is much more than a lost opportunity.
Every delay in getting ahead of the crisis translates into a longer “to-do list” and a more expensive bill. Without further progress, borrowing costs for vulnerable countries will remain too high. Companies’ investment and hiring plans will be delayed, accentuating the economic slowdown. And private capital will remain nervous – thus adding to funding uncertainties and making it more difficult to channel working capital to small and medium-sized enterprises.
With such prospects, the European Central Bank, an institution with much greater policy agility, will again find itself conflicted at its policy meeting next week. If it buys peripheral bonds (directly or through a new longer-term refinancing operation), it will just provide temporary breathing room that again risks evaporating. If it remains on the sidelines, it risks adding to the turmoil.
Without additional measures, it seems inevitable it will only be a matter of time until European leaders gather again for a crisis management meeting; and they will find the challenges even more onerous.