Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a former managing director of the IMF, former governor of the Banque de France and former president of the European Bank for Reconstruction and Development
A sovereign currency represents the quintessence of the issuing country: the collective characteristics of the nation. The single currency of the EU, the euro, is far removed from this status. Rather than demonstrating unity, it is a continuing source of tension and dispute among the eurozone’s constituents.
At a time when the European Central Bank needs to go further in “normalising” interest rates to counter persistent inflation, member states and the European Commission must demonstrate the will for corrective action. Unless new policies are forthcoming, a new euro crisis could erupt sooner or later.
The euro is the second global currency after the dollar. But this success cannot hide deep internal divisions. The reasons are manifold. There are as many budgetary policies as member states. Perceptions of the need to tackle inflation vary widely. Since the 1960s, the EU has become less guided by strong structural policies in areas such as industry, agriculture, energy competition. Instead, it has moved to a single market without community preferences, often overridden by powerful national trends.
Euro area growth has lagged behind that of the US. Since 1995, real US gross domestic product has increased more than 90 per cent, against the euro area’s more than 50 per cent. Eliminating the risks of fluctuating exchange rates favours product specialisation. As a result, the euro has reinforced the more industrialised euro area members at the expense of those in industrial decline.
Macroeconomic divergence is further demonstrated by the so-called Target-2 imbalances that represent the national central banks’ intra-euro area claims and liabilities. Spain and Italy register liabilities of around 28 per cent of gross domestic product, while Germany has a net claim of about 26 per cent.
What can be done? One way forward would be to solve EU banking fragmentation. This would require harmonising national rules and overcoming host-country ringfencing practices. Steps are needed to drive forward capital market union. The same is true of the need for a safe European financial asset, held back by the absence of a common tax policy.
Another basic problem has been ultra-accommodative ECB monetary policies. These have disincentivised structural reforms, particularly in France and Italy. Near-zero interest rates have made public deficits easily financeable. The ECB’s quantitative easing reduced problems caused by spreads in bond yields but heightened general indebtedness and the vulnerability of the financial system.
How should the ECB take into account the risks of financial fragmentation? To tackle persistent inflation, it would be wise to start a resolute process of quantitative tightening to eliminate excess liquidity. Fears of rising European spreads must not dominate monetary decision-making. But sooner or later, structural spreads — reflecting accumulating fiscal and structural deficiencies — will reappear.
Member states must adjust their economic and fiscal policies accordingly. The revision of the stability and growth pact must be ambitious and immediately effective to prevent an imminent euro crisis. There must be a gradual convergence of member states’ budgetary polices. The Commission’s proposed case-by-case framework seems a good approach. The pace of return to public debt below 60 per cent of GDP should be specifically adapted to each country.
The macroeconomic imbalance procedure must be rigorously respected within the framework of equal treatment and multilateral surveillance, either by the Commission or by an independent budgetary authority. Current account adjustments should concern countries with both structural deficits and surpluses. It is neither possible nor honest to expect the countries of the south indefinitely to reduce economic growth to rein in deficits to compensate for northern surpluses. A symmetrical adjustment mechanism is needed where surpluses are treated in the same way as deficits.
Europe’s complex system of attempting to manage monetary union without a credible economic stability mechanism is unsustainable in the long term. Policymakers, and above all the Commission, must assume responsibilities in respecting economic discipline. This requires independence, competence, vision and courage. At present we see a process of fiscal, inflationary and economic slippage — and the danger that the more “virtuous” countries of the north end up paying for the ensuing problems. It is time for Europe to take its destiny into its own hands.
