- Europe’s Economic and Monetary Union
- the euro crisis forced the reform of the EMU
- European semester and rules-based governance
- the statelessness of the EMU
- EU101: Introduction to the European integration process.1
- EU110: The European Union as a federal system.2
The Economic and Monetary Union or else EMU is a stage in the integration process that is more advanced than that of the single market. It expands into all areas of policy that concern economic governance, namely, budgetary and fiscal policy, monetary affairs, and financial regulation. A fully realised EMU must be considered the evolutionary phase prior to political unification.
Europe’s Economic and Monetary Union was established together with the European Union in the 1990s. It was to have an official currency: the euro. Monetary policy would be conferred to a new institution: the European Central Bank. There would be a European System of Central Banks meant to coordinate monetary affairs between euro and non-euro members. As for the euro area, it would be governed monetarily by the Eurosystem, which is a federated formation of the ECB and the National Central Banks, with the former standing as the supreme authority.
True to the inherent gradualism of European integration, the EMU was not created as a finished article. Its original design was the mere skeleton of a genuine Economic and Monetary Union.
On the fiscal front, all it had was a small set of rules governing a handful of macroeconomic indicators. I am referring to the Stability and Growth Pact. You may have heard of the 3% budget deficit and the 60% public debt. These are envisaged in that pact. There was next to nothing concerning macroeconomics in general, such as the trade balance, capital flows, and the like. Furthermore, there were no credible mechanisms for enforcing the rules of the Stability and Growth Pact.
On the monetary and financial fronts, the EMU remained largely fragmented along national lines. There were not enough rules to ensure a level playing field, or to regulate the system in a uniform and orderly fashion. Bank supervision remained with the national governments as did the concentration of financial risk. If a bank were to fail, the cost would only fall on the national government concerned. The idea was that each Member State had to take care for its own affairs. And the assumption for that was that each national government could indeed remain sovereign over those issues, in spite of the fact that it had transferred much of its related power to the supranational level
The incompleteness of the EMU meant that the integrity of the architecture was contingent on intergovernmental relations. The problem with that sort of arrangement is that interests tend to coagulate along national lines. There is no means of expressing the common good, that which would be beneficial for the EMU at-large. It therefore is no coincidence that little progress was achieved in the first years of the EMU’s lifecycle.
Then the financial crisis hit, forcing new conditions on European policy-makers. Several assumptions were either proven false or rendered obsolete. One was that risks could never be mutualised at the European level. This did eventually happen, courtesy of the bailout programmes to crisis-struck countries, and eventually via the creation of the European Stability Mechanism, as well as the unconventional policies introduced by the ECB. Another false belief was that the rules of the Stability and Growth Pact were sufficient for establishing a viable EMU. It was not long before they were revised and greatly expanded upon by a comprehensive legal framework on economic governance and coordination. The third assumption was that bank supervision could remain divided along national borders. Here too reforms were made to ensure that this would become an area for EU policy.
The euro crisis signaled the end of the original EMU. Such has been the content and reach of the reforms that precious little remains of what its architects had envisaged. The response to the crisis aimed at reducing the accumulation of risk in the system. It tried to both tighten up the rules and turn them into matters of shared competence between the Union and the Member States.
To appreciate the current framework for Europe’s economic governance, we will examine all main reforms that were introduced on the three fronts of the euro crisis: banking, budgets, and macroeconomics.
As concerns banks, new legislation was passed that aimed at making financial institutions more robust to economic shocks. This body of rules is commonly referred to as the Single Rulebook. It covers capital requirements, deposit guarantees, and bank resolution.3 The purpose of the Single Rulebook is to create a certain uniformity in bank regulation, which is a prerequisite for effective prudential policy.
By “prudential policy” we refer to two powers, both of which ultimately rest with the European Central Bank: (1) the first is on the macro perspective and concerns the monitoring of the financial sector for its continued compliance with the Single Rulebook and for assessing the degree of systemic risk, (2) the second takes place on the micro level and is about the intervention of the authorities in the internal management of a troubled financial institution, either for the sake of forcing it to adopt measures for its recovery, or lead it to its orderly restructuring or breakup. The ECB’s macroprudential policy is exercised under the Single Supervisory Mechanism or SSM, while its microprudential capacity is made available by the Single Resolution Mechanism or SRM.
Technically, the SRM also has another component to it, that of a common fund which is meant to cover for the costs related to a bank resolution. These are considered key to Europe’s nascent banking union. The idea is that this new system consists of three pillars: one is macroprudential policy to ensure the uniformity of financial oversight, the second is microprudential policy to establish a common framework for addressing any irregularities in the system in an orderly fashion, and the third is a common deposit insurance scheme which is meant to bring all of the system’s bank to a common threshold of trustworthiness. As of now, the third pillar remains elusive, though it is expected to come into being in one way or another.
While on the subject, we should note that all of these legal-institutional elements of financial regulation were only recently introduced. Starting from 2011, the European Supervisory Authorities were established, whose common task is to draw up the prudential rules. For the sake of reference, these entities are: (i) the European Banking Authority,4 (ii) the European Securities and Markets Authority,5 and (iii) the European Insurance and Occupational Pensions Authority.6 Adding to them, there also exists the European Systemic Risk Board within the European Central Bank, which was established at around the same time.7
Turning towards the second area of reforms in the EMU, we may note the changes made to the rules concerning state finances.8 There is a comprehensive legal framework in place. As we mentioned before, there is the Stability and Growth Pact. This has been revised several times since its introduction, with a substantial change made in 2011 to ensure more effective surveillance over budgets and deficits.
Adding to the SGP we have a new intergovernmental Treaty outside the EU legal corpus. It is the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union. This treaty introduces several provisions on budgetary control such as the notion of the structural deficit or the concept of the medium-term budgetary objective. In short, it is there to further strengthen the EU’s legal provisions over fiscal supervision. What is also important to note about this treaty, is that it is a prime example of how inventive and flexible European policy-makers can be whenever they find EU laws to be rigid and inadequate for the task at hand. Given its scope, it also goes to show that the euro area has specific needs, which will most likely be further institutionalised in future amendments to the EU’s primary law.
Coming to the relevant secondary legislation which also extends into economic policy, the other area of reform, we observe that economic governance is based on two sets of laws best known as the Two-Pack and the Six-Pack. As their names suggest, the former consists of two legal instruments and the latter of six. What these rules basically do is extend the rationale of the Stability and Growth Pact, while also broadening the scope of policy coordination well beyond the narrow confines of budgetary issues. This ruleset covers everything from how national budgets are to be monitored to which macroeconomic indicators will be accounted for in evaluating the competitiveness of the Member States.
The actual exercise of economic governance takes place within the so-called “European Semester”. This is the formal procedure that starts at the beginning of each calendar year and covers its first half. The Commission is tasked with assessing the macroeconomic outlook of each state and provide recommendations on any items that need to be addressed. These have to be considered by the government in question when preparing its draft budget. Such drafts are sent to the European Commission towards the end of the year in order to be evaluated for their compliance with the rules and to check whether the necessary adjustments were made as per the Commission’s guidance.
What renders the European Semester something more than a mere exercise in issuing recommendations and publishing economic reports, is that the Commission has enhanced powers over the enforcement of the rules. It can do so both with respect to any excessive macroeconomic imbalances it may identify, or to any excessive deficit in a state’s budget. The Commission may choose to place a closer check on governments that do not comply with the rules and, if necessary, proceed to impose sanctions. This constitutes a qualitative change from the original design of the EMU where the European level had little significance.
What all these reforms to the governance of the system have not addressed is the core idea underpinning the EMU: that of not having a central authority to exercise economic policy. The EMU was created as a union without an overarching sovereign, without the foundations of a state. It was—and to this day remains—a rules-based system of policy coordination between nation states.
As we discussed in our seminar about the European Union as a federal system, it is clear that while economic governance is a shared competence between the Union and the Member States, the supranational level does not have sovereignty in its own right. There is no such thing as a European Finance Ministry meant to draw up a coherent economic policy for the whole area. The EMU still lacks a common treasury. There are national fiscal policies but no European fiscal policy. This creates asymmetries on two levels: (1) there is no means to iron out imbalances between states, and (2) the European Central Bank has no fiscal counter-party that could help it boost aggregate demand, hence its inability to even meet its own target of 2% medium term inflation.9
Other areas that may still be identified as needing immediate attention are the following:
- On the executive level, there is a clear gap between a centralised ruleset and decentralised implementation. This may be addressed by the creation of a Union-level institution responsible for economic governance: for the sake of this seminar we will call it the European Finance Ministry.
- On fiscal issues, it is evident that common rules are not enough to address structural imbalances between the Member States. Corrections of this sort would require a single authority that would instantiate the Union’s fiscal capacity: a European Treasury.
- As for the overall legitimacy of the edifice, an accountable body needs to be made responsible for the decisions on economic governance. No one can hold accountable a procedure, the European Semester that is. Such an entity could either be the European Finance Ministry or a completely reformed Eurogroup. In the latter scenario, the Eurogroup would have to be transformed into a perfectly legal entity that would act as a proper formation of the Council of the European Union for euro-specific affairs.
Speculation on future reforms notwithstanding, the gist is that the EMU remains a work in progress.10 This is no surprise given the gradualism of European integration. Europe’s Economic and Monetary Union was conceived as a minimal legal framework that would preserve the impression of independence among its participating states. The euro crisis forced policy-makers to abandon such fancies and to proceed with what is, in essence, a state-building exercise. All of the reforms we have mentioned could be summerised as the effort to correct the EMU’s original statelessness. In this regard, the reforms are addressing a central flaw of the original architecture. If they are to be pursued towards their logical end then the EMU will eventually feature all the trappings of a sovereign state, at least insofar as economic governance is concerned. In addition to its monetary sovereignty, it will have genuine executive powers, Union-level fiscal power, and be in charge of a fully-integrated financial system.
What has been largely absent from the policy response to the euro crisis, and indeed what remains outside the scope of integration is social economic policy. There will be no common unemployment scheme over the foreseeable future, no common investment strategy to create jobs in areas that have high levels of unemployment. Nothing of the sort. Such policies remain a national prerogative which, to be frank, is rather weird and contrary to the idea of completing the EMU. It makes little sense to have the national level be relatively enfeebled on fiscal and economic issues yet continue to expect from it to deliver all of the public goods that are necessary in a modern social market economy. A genuine EMU would have to have the power to deliver public goods for the system as a whole and to do so in order to promote the common interest.
In conclusion, we should note just how important secondary legislation is. It is often claimed that any meaningful change to the EU must be realised by means of an amendment to its primary law. The argument is that the EU Treaties are rigid and leave little scope for progress. My understanding is that this line of reasoning omits crucial information, such as the ample evidence provided by the euro crisis. Policy-makers did find ways to overcome this supposed rigidity. The EMU has undergone thoroughgoing reform and can still be altered further without the need of amending the primary law. Also, there always exists the option of an intergovernmental accord outside the Union’s legal order.
Whatever the case, we should not underestimate a couple of things:
- the capacity of European leaders to overcome both their differences and whatever obstacles may exist in a given institutional arrangement;
- we should understand that, either we like it or not, too much political capital has already been invested in the euro, it is the cornerstone of the EU, and will not be abolished for as long as the European Union is considered preferable to other forms of politics on the continental scale.
The EMU is here to stay. The latest roadmap for its reform has already been made public. It is known as the “Five Presidents Report”.11 It outlines all of the new pieces of legislation that will be introduced over the short-to-medium term. We should expect to see concrete steps in that direction towards the end of this year or perhaps some time during 2017. It will be interesting to see how these will impact the present order as well as anticipate any amendments that will eventually be made to the European Treaties. Ultimately though, it will show us whether the EMU will start moving away from the current paradigm of economic governance towards the establishment of a Union-level economic government.
Europe’s economic governance: context and reform prospects. My contribution to the journal of the Catalan Greens. Published on January 26, 2016. [^]
The Five Presidents’ Report: Completing Europe’s Economic and Monetary Union. Published by the European Commission on June 22, 2015. [^]