The euro is the European Union’s official currency. All Member States will eventually have to adopt it, save a couple of exceptions.1 The euro area, also referred to in the media as the “eurozone”, currently comprises 19 of the 28 EU nation states.2 Europe’s single currency was introduced in 1999, as envisaged by the Treaty of Maastricht which was signed a few years earlier. That Treaty established the European Union as the successor organisation to the European Economic Community.3
What this concatenation of key events has in common is an underlying paradigm shift in European politics. The scope of the integration process was no longer to be limited to the abolition of trade barriers and other impediments to cross-border economic activity. European leaders wanted to turn their Community into something more than a common market or regional trading block. They saw Europe as a rising power boosted by the collapse of the Soviet Union. To that end, they set out to deepen the ties between their nations in an effort to pursue political unification. The European Union with its single currency signals the formal beginning of that change in focus.4
Monetary means to political ends
The euro, just like all fiat money, is a political project. An instrument for increasing the economic interconnectedness of its member countries and a catalyst for their coalescence into a unified monetary, fiscal, financial, and ultimately political whole.
By joining the euro, nation states opt to transfer their sovereignty over monetary policy to the European level. In so doing they deprive themselves of a major instrument for macroeconomic control or, put differently, of a powerful means of indirectly protecting the domestic economy from foreign competition. Without the ability to engage in such practices as adjusting the money supply or fiddling with exchange rates, nations can only rely on structural factors (e.g. labour and investment policy) and careful budgetary planning to enhance their outlook and competitiveness.
Member States further agree to delegate substantial powers over fiscal policy and economic coordination to the supranational level. Europe’s Economic and Monetary Union (EMU), of which the euro is the ultimate stage of integration, entails much more than uniformity of monetary policy. It is an elaborate system of rules and institutional arrangements for regulating and aligning the fiscal and economic policy of all national governments, with additional restrictions for those whose currency already is the euro.
What countries lose in terms of flexibility and the capacity for unilateral action on the economic front, they gain in the form of stable prices, increased trade with their European partners as well as the political advantages of being part of the “European core”.
The assumption is that at least over the longer term, the presence of the euro as well as the shared responsibility enforced by the EMU contribute to the stability and robustness of the European architecture. No Member State is allowed to engage in unfair competition with its peers. In principle, there is no “beggar thy neighbour” practices within the EMU. Besides, the euro is an international reserve currency. Adopting it is an appealing proposition for nations that want or need to increase their [collective] bargaining power on matters of global trade. While the specifics may vary, the euro provides incentives for countries to continue to cooperate and to pursue further integration.
Understandably the case for the euro may appear implausible under the circumstances, especially given the EU’s recent economic woes. For many the perception of it is that of a failed venture; a flawed currency area that is, according to some vociferous critics, teetering on the verge of its collapse.
Opinions on the actuality and future prospects of the euro notwithstanding, the policy choices of European decision-makers reveal the kind of resolve and commitment that will not allow the euro to fail. The Economic and Monetary Union has gone through some profound reforms in recent years, largely as a reaction to the “euro crisis”.
In terms of its legal-institutional arrangements, the EMU appears as much more of a complete puzzle today than it was less than a decade ago. What is in place is markedly different from what was envisaged in the 1990s, especially in terms of the powers transferred to the European level for the purposes of fiscal discipline, governance, and economic coordination.
The incompleteness of the original EMU
The Economic and Monetary Union is an advanced stage in the integration process that expands upon the achievements on the single market. The single market is a rather decentralised system. Member States agree to mutually abolish trade restrictions between them and adopt common standards. They do so by means of implementing supranational legislation. The single market is little more than a free trade area. There is no EU-level authority for regulating economic policy as such. That is left to the discretion of national governments.
Whereas the EMU ramifies to constitutional issues and matters of sovereignty. Power is delegated to the European level either in the form of an exclusive competence, as in the case of monetary policy in the euro area, or in a shared competence between the EU and the Member States.
Whatever the case, the result is the same from the perspective of a national government: unilateral action on economic policy is no longer an option. All key issues become part of the policy-making process of the EU and of the multi-faceted negotiations that characterise it.
All EU Member States are part of the EMU, yet only the euro countries are bound by a subset of legal provisions on fiscal policy. The difference here is one of degree. The euro area requires closer checks on national budgets due to the uniformity it imposes on the monetary front.
The rationale for prohibiting unilateral action is rooted in economics. A monetary union unites economies in such a way that negative spill-over effects can easily disrupt the entire system. Frivolous spending by one government can result in losses for the rest of the area. If anything, the recent financial crisis revealed the extent to which euro countries are interdependent.
Back in the 1990s the architects of the EU and the euro did not foresee the implications of monetary uniformity across diverse national economies. They did not anticipate a multitude of concurrent crises unfolding on fiscal, banking, and macroeconomic fronts. The original EMU lacked both the tools and the laws for coping with such a set of challenges as those generated by the euro crisis.
On fiscal issues, the original EMU was over-confident in the viability of a generic rules-based governance model. Monetary policy was trusted in the hands of the European Central Bank while each national government was to pursue its own fiscal path provided it followed a handful of rules as per the Stability and Growth Pact (SGP). Most relevant among them are the two rules of 3% budget deficit and 60% public debt.
The approach was mechanistic and excessively optimistic in its underlying assumptions. A Member State was thought to be contributing to the optimal functionality of the EMU if it was operating within the SGP’s constraints. There was next to nothing concerning macroeconomics in general, such as the trade balance, capital flows, and the like. The effects of monetary integration on a cross-border, systemic basis were not considered to their full extent. As for the very rules enshrined in the SGP, the European level lacked credible mechanisms for enforcing them, hence their de facto obsolescence in the build up to the euro crisis.
On the financial front, the original EMU remained divided along national lines. The rules that would create a level-playing field were either inadequate or insufficient. Bank supervision remained a national prerogative, while banking risk was not monitored in the context of monetary union but as yet another domestic affair. The cost of a failed bank would be incurred by the respective national government.
The rationale was that every EU Member State had to put its own house in order. Under the SGP it had the obligation to do so, while it was granted the freedom of deciding on the specifics thereof. Implicit to this order was the assumption that nation states indeed preserved the necessary sovereign authority to fully control their economy. With EMU membership limiting the scope for independent macroeconomic planning, this was proven to be a largely false and misguided belief.
Overall, the original Economic and Monetary Union was a rather incomplete edifice. It could go on working during the good times, but it would most certainly disintegrate under the duress of the financial crisis. In terms of governance, such incompleteness meant that economic coordination was predicated on inter-state politics. The single most evident weakness therein is that the implementation of the rules becomes a matter of contest and of negotiating the results. One national agenda contradicts the others without the systemic economic good—the interest of the EMU at-large—ever being considered.
The EMU was reformed courtesy of the Great Recession. The new financial environment forced European decision-makers to reconsider their assumptions. Many of the tenets that underpinned the pre-crisis EMU were either proven fallacious or irrelevant. More specifically:
- The inadequacy of the no-bailout clause. The European Treaties have a provision that prohibits either the Union or the Member States to incur the debts of another government.5 The thinking is that losses should never be mutualised at the European level. Every nation state should be held responsible for its own fiscal position (hence the SGP). While that may be good in theory, it seldom works in practice. As a matter of fact, the spirit of the EU’s no-bailout clause has been effectively rendered void. Member States did take losses whose origin was external to their domestic economy. They did so in the form of contributing funds to the bail-out programmes that were provided to the crisis-struck countries (Greece still is one), while they also reserved resources for the European Stability Mechanism, the de facto fiscal backstop of the EMU.
- The ineffectiveness of a generic SGP. While the budget deficit and the public debt are important metrics, they cannot shape the prospects of an economy. Not every economic factor is a function of both or either of these two. In the case of the EMU, the problem is compounded by the fact that Member States have dismantled direct trade restrictions between them while they have given up their monetary sovereignty. Phenomena with a cross-border reach cannot be tackled by any one government operating on its own accord, and are certainly not contingent on a couple of fiscal indices.
- The futility of national oversight over banks with cross-border activities. Financial institutions are among the greatest beneficiaries of the single market. For them the EMU means that they can engage in operations abroad without having to worry that the government of the country in which they operate suddenly decides to radically change the economic environment, say, by imposing trade restrictions. Reforms to the EMU can only come from the supranational level. In practice, this means that capital gets to move almost totally unencumbered within the system. But the same was not true for bank oversight. There was a need for institutions that could perform that role at the European level. Originally these did not exist. Each national government had to supervise financial institutions on its own. Systemic risk on a EMU-wide scale would thus go unchecked.
The reformed EMU
What triggered the reform of the EMU was the euro crisis. It exposed the design flaws of the system. Policy-makers had to address them or risk annulling decades of integration. The euro would not be allowed to fail at the first series of obstacles.
The policy response to the crisis focused on two areas: (i) bank regulation, (ii) state finances and economic coordination. Existing rules were tighten up while new legislation and a couple of treaties were introduced that turned economic governance into a matter of shared competence between the Union and the Member States.
Regarding banks a set of laws were passed that aimed at improving their robustness to economic shocks. This body of legislation is also known as the Single Rulebook. It regulates capital requirements, deposit guarantees, and bank resolution.6 Its objective is to create a certain uniformity in bank regulation, which is a prerequisite for effective prudential policy.
By “prudential policy” we refer to the supervision of the financial sector. It consists of two functions, both of which ultimately rest with the European Central Bank:
- Macroprudential. The macro perspective examines aggregates across the financial system in order to assess the presence and degree of systemic risk. It also evaluates the compliance of the sector with the Single Rulebook. This policy is exercised under the Single Supervisory Mechanism (SSM).
- Microprudential. The micro level is for singling out a troubled bank for special measures. Provided certain conditions, the authorities may intervene in its internal management for the sake of its recovery, force its orderly restructuring or even lead to its breakup. The Single Resolution Mechanism (SRM) is in place to perform this function.
The SRM has another component to it: a common fund to cover the costs related to bank resolution. The idea is that the nascent banking union consists of three pillars: (a) macroprudential policy to enforce the uniformity of financial oversight, (b) microprudential policy to tackle any irregularities in the system, and (c) a common deposit insurance scheme meant to bring all of the system’s banks under a common denominator of trustworthiness. As of now, the third pillar remains a work in progress. The relevant legislation is still in the drafting phase and is expected to be put forward over the near-to-medium term.
All the legal-institutional arrangements for financial supervision were introduced amid the euro crisis. In 2011, the European Supervisory Authorities were established, whose ultimate task is to formulate the prudential rules. These bodies are: (i) the European Banking Authority,7 (ii) the European Securities and Markets Authority,8 and (iii) the European Insurance and Occupational Pensions Authority.9 The European Systemic Risk Board at the European Central Bank, was also established at around the same time.10
Prior to the crisis, the EMU had no effective prudential policy. Whether these will be enough remains to be determined.
State finances and economic coordination
In 2011 amendments were made to the Stability and Growth Pact to ensure more effective surveillance over state budgets and deficits.11 A new Treaty with a similar scope though outside the European acquis was also ratified by almost all Member States. The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union, most commonly referred to as the “Fiscal Compact”. Enshrined in it are several provisions for budgetary discipline, such as the concept of the structural deficit or the notion of the medium-term budgetary objective.
The Fiscal Compact was an ad hoc response to the EMU’s design flaws. Given that this is an international treaty, it effectively enjoys a constitutional status. That strengthens the European level by eliminating the scope of national governments for unilateral budgetary planning. The Fiscal Compact may be outside the EU acquis, but it remains aligned with it. The plan is that it will eventually be incorporated in the acquis some time over the medium term. The reasons for it being a new treaty, rather than just another piece of EU legislation, can be traced to legal and time constraints. In principle, the Fiscal Compact partakes of the same underlying approach to economic policy as the rest of European law.12
On this area of policy there also exists an extensive corpus of secondary law. Europe’s new framework of economic governance is based on two sets of legislation known as the Two-Pack and the Six-Pack. The former consists of two legal instruments. The latter of six. What these laws essentially do is extend and further specify the rationale of the Stability and Growth Pact. They also broaden the extent of policy coordination well beyond the confines of budgetary policy. Economic governance covers everything from the drafting and monitoring of state budgets, to which macroeconomic indicators will be examined in the evaluation of the relative competitiveness of Member States.
The process of the EMU’s governance takes place within the context of the so-called “European Semester”. This is a procedure that starts with the calendar year and covers its first half. The Commission assesses the economic outlook of each state and proceeds to issue recommendations on any issue that may need to be addressed. These recommendations will need to be considered by the government in question prior to the drafting of its next budget. Draft budgets must be sent back to the Commission for review.
The European Semester is not a bureaucratic exercise in just issuing opinions and recommendations and in publishing macroeconomic reports, though it may well appear that way. It has a profound effect on policy. Unlike the original design of the EMU, the Commission enjoys extensive powers over the enforcement of the rules. It can proceed to impose restrictions or even sanctions in cases where it identifies any excessive macroeconomic imbalances, or deviations from the targets on the budget deficit.
Governance not government
What remains of the Economic and Monetary Union’s original design is the lack of a central authority for exercising economic policy. Everything has been harmonised except decision-making. The EMU continues to be a rules-based system that binds together nation states that are otherwise thought of as independent. There is no overarching sovereign, no European state that underpins the euro (in the same way other currencies are backed by a sovereign state).
While economic governance is a shared competence between the Union and the Member States, there is next to nothing in terms of specialised EU institutions for economic policy outside the scope of intergovernmental decision-making. For example, the EU does not have a European Finance Ministry that could be tasked with formulating a coherent, system-wide economic policy. The EU does not have its own fiscal capacity manifesting as a European Treasury. It can neither raise taxes nor issue debt instruments. There only are national fiscal policies that need to be coordinated between them, not with respect to a European fiscal policy.
To this end, shared competence on economic governance means that the EMU proceeds based on what is the best negotiated result between national governments, not what is necessarily needed for the good of the system at-large. This kind of mismatch between the legal corpus and the political process can engender asymmetries on two levels:
- there is no defined, and hence transparent, procedure for tackling in a timely fashion macroeconomic imbalances that are cross-border in nature;
- the European Central Bank has trouble fulfilling its mandate on targeting inflation, since it cannot enjoy the support of a counter-party fiscal authority that could help prop up aggregate demand.
The gist of the matter is that the EMU remains a work in progress. It is not that long ago that the euro crisis provided the impetus for its thoroughgoing reform. The changes made to its design can all be summarised as a concerted effort at state building at the supranational level; a corrective to the EMU’s original statelessness.
The latest roadmap for the completion of the EMU was published a little less than a year ago. It is the “Five Presidents Report”, which describes in outline all of the new initiatives or pieces of legislation that will be put forward over the short-to-medium term.13 We can expect something more specific towards the end of this year or more likely during 2017.
Whatever the case, the euro is here to stay. Without it Europe’s Economic and Monetary Union would be of no use. The European Union would then have a hard time evolving into anything more than a regional trading block. Too much political capital is invested in the ultimate success of the single currency. The very scope of European integration hinges on it. It would be extremely unlikely for policy-makers to abandon a project that was initiated in the early 1990s and which [tacitly] aims at the political unification of European nations.
Couched in these terms, it might as well be argued that those who are foreseeing the impeding demise of the euro are placing a bet against Europe’s collective ambition to remain relevant in the ever globalising world of the 21st century.
There are a couple of exceptions to the rule of adopting the euro. Read the official summary for the United Kingdom’s and Denmark’s exemption from the third stage of Economic and Monetary Union. Sweden is another country that does not look likely to join the euro area. Technically, it has not been granted a formal opt-out. It just “fails” to meet the requirements. [^]
In technical terms, the euro represents the third stage of Economic and Monetary Union (EMU). It is meant to complete the development of the single market into a cohesive economy. All EU Member States are part of the EMU. Not all of them have reached the third stage, though they will eventually have to (opt-outs notwithstanding). [^]
The no-bailout clause is enshrined in Article 125 of the Treaty on the Functioning of the European Union. Strictly speaking, it does include language that can be interpreted in justification of the various bail-out schemes. [^]
What is interesting about the modalities of the Fiscal Compact is that it reveals exactly how creative European decision-makers can be when they find that the EU framework hampers their plans. Given the scope of the treaty, it also shows that the euro area has specific needs, which will most likely be further defined and institutionalised in future amendments to the EU’s primary law. [^]