Europe

GLOBAL INVESTOR 1.14 — 04
Reform agenda
Toward a less imperfect
monetary union
The Eurozone lacked robust institutions to deal with the fallout from the Greek debt default and the
financial contagion that followed. In response to the crisis, the establishment of such institutions
has begun in earnest. However, the reform and economic recovery process of some of the member
states is far from complete.
TEXT OLIVER ADLER
Head of Economic Research
Long before concrete plans for European Economic and
Monetary Union (EMU) were developed in the mid-1990s, the
concept of a single currency had been perceived by many
as a means to boost not just economic, but above all political
convergence in Europe. Indeed, it proved easier to reach agreement
on the high-level principle of a common currency than on the “nittygritty”
measures and reforms that would ultimately be needed to make
it work – such as the integration and coordination of banking regulation
and common fiscal policy. Consequently, the euro was launched
in 2002 without most of this crucial institutional structure. Some saw
this as a potentially fatal omission, while others viewed it as a gap
that could not have been filled beforehand, but which participants
would be able to tackle later to keep the euro together.
In the first years of its existence, the serious “design flaws” of the
monetary union were well disguised: Germany had entered the union
with an overvalued exchange rate, and the “periphery” generally with
undervalued exchange rates. While Germany struggled to regain competitiveness,
the periphery economies were boosted. The economic
upswing in the south, combined with their seemingly cheap assets,
attracted enormous capital inflows not just from Germany, but from
other surplus countries and regions as well.
Credit expansion further boosted economic growth in the periphery,
but also drove up wages and prices, and generated asset bubbles
of varying dimensions – the Spanish and Irish housing boom being the
most dramatic. By the time the global financial crisis hit, the periphery
had become uncompetitive as well as over-levered, and thus highly
vulnerable to economic or financial shocks. The event that triggered
the EMU crisis was the insolvency of the Greek government in early
2010. It not only proved to investors that the rules for enforcing fiscal
discipline (the infamous “Maastricht criteria”) had failed, but also revealed
the severe lack of stabilizing institutions in EMU.
The history of the EMU crisis depicted on pages 6 to 7 is thus one
of a prolonged struggle between member states over how to construct
the missing institutions, what powers to give them and how to fund
them. This process was uneven, but the outcome, in our view, is a
more complete – though still imperfect – monetary union and thus
2014
EU Countries with euro
effectively a major step toward a political union. Contrary to the
predictions of many skeptics, the institutions of EMU have been
strengthened rather than weakened by the crisis.
As we show on the following pages, however, progress in individual
member states is far more “patchy.” Some countries, such as
Spain, have made considerable strides in reforming their labor markets
and their fiscal institutions. Others, notably Italy, and also France,
have a much longer way to go. Meanwhile, a still partly dysfunctional
and far from integrated Eurozone banking system and capital market
remains a hindrance to a vigorous and synchronous economic recovery.
That said, the ascendance of the common central bank and financial
regulator should continue to drive this integration process, while also
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