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Economic and monetary challenges - Prospects of the EU economy and the Eurozone

Encouraging structural reforms in the EU

By Dombrovskis Valdis - Vice-President for Euro and Social Dialogue, European Commission

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The crisis of 2008 and its aftermath have exposed the architectural weaknesses enshrined in Europe’s Economic and Monetary Union since the Maastricht Treaty. Introduction of the common currency was a grand political step in itself but, the fathers of the EMU lacked the political will to go all the way. Instead of developing the vital elements of the fiscal union, they relied solely on the fiscal discipline of Member States. Today, almost 25 years later, the fiscal integration remains a politically contentious issue still. Nevertheless, the financial and economic turmoil is a proof to many that a system of common currency without a common fiscal policy is inherently inadequate and a fundamental reform is inevitable if we are to handle any future shocks effectively. Important reforms that have been introduced in the last couple of years improved the financial and fiscal resilience of the Eurozone. However, more is needed.

We have seen that single monetary policy cannot solve problems of Member States in different stages of their economic cycles. Market based adjustment mechanisms proved insufficient and slow to mitigate long lasting negative effects of the downturn on the national budgets. The debt overhang, cyclical differences, structural rigidities as well as low labor mobility keep the Eurozone exposed and vulnerable.

Lack of trust and increasing doubts about the viability of the EU project among its citizens are dangerous consequences of protracted economic problems. Rise of populist and anti-establishment parties undermines the political stability, which then translates into diminishing support for the Eurozone and for the EU. Political frictions among Member States are starting to spill over into other policy areas as well.

Diverging views even on the basic questions, such as the definition and format of the fiscal union hold back the move towards further integration. For some, efforts should not go beyond fiscal coordination and surveillance. For others, fiscal union ultimately means the provision of risk sharing mechanisms. In fact, these two approaches should be considered complementary and part of the same long-term project.

It should be stressed that an explicit Eurozone budget per se is not necessary in order to equip the Union with a macroeconomic stabilization function. The economic essence can be embodied in a form of a fiscal instrument, which would be less demanding politically and legally speaking. Naturally, chief among the hurdles to the introduction of a fiscal union are the fears of moral hazard and permanent transfers. My view is that such fears are overblown and can be addressed with a careful design of the specific fiscal instruments.

The EU is making better use of its tools to step up implementation of structural reforms as an element to address Europe’s fragile recovery and continuous low growth potential.

Having a close association with the cycle, households’ income protection presents itself as an optimal candidate to fulfil the stabilization function. Insuring against large cyclical fluctuations, temporarily, and only in the case of significant shocks, the European Unemployment Insurance Scheme could tackle the issue of moral hazard and permanent transfers. It could become an impetus for a much larger project of improving labor mobility in the EU. Lastly, by reaching out directly to citizens, the scheme could also enhance social and territorial cohesion in the EU. In case of Pan-European shocks, especially when ECB faces zero lower bound, a common investment program could help boost domestic demand and growth. Operational and implementation challenges would be reduced as this instrument could build on the existing European Fund for Strategic Investments.

Benefits of closing the gaps in the EMU´s institutional design appear straightforward, both, in the short and the long term perspective. In the near term, a credible commitment to make the Eurozone more resilient would immediately improve investors’ confidence and business environment. In the long run, stability and predictability would improve growth perspectives and economic and political stability of the EU as a whole.

Sure, this is a grand vision and it won’t be done overnight. But unless we are ready to give up on the project of the currency union, we must begin a serious discussion on the project of fiscal union.