This analysis was originally published by Initiative Neue Soziale Marktwirtschaft. The original text is in German, but an executive summary in English can be found below.
A Framework for the European Economic and Monetary Union – 6 Principles for Stability
Christian Fahrholz, Andreas Freytag and Christoph Ohler
The sovereign debt crisis in the European Economic and Monetary Union (EMU) clearly demonstrates the costs if an economic union fails to follow effective, comprehensive rules. There were inconsistencies in regulations of the EMU and an absence of sanctions against infraction, which in the past furthered the laxity of European economic cooperation. In this case, the existing EMU regulations did not prevent many European member states from accumulating an unsustainable level of debt. This burden currently is burying the Euro zone’s ability to function.
The EU treaty law effectively made it possible, at least in the short-term, for individual member states to realize the advantages of EMU membership. However, these provisions did not achieve the correct balance of incentives to implement the common good, namely the long-term functioning of the Euro zone. In this sense, the ongoing crisis is undoubtedly and primarily a consequence of politico-economic malfunction. This is not a monetary crisis, rather at its center this crisis establishes a serious crisis of confidence in politics. Citizens‘ and investors‘ trust in the ability (and will) of political decision makers to ensure strong economies and the stability of the common currency zone has measurably declined. Subsequently, a vicious circle can form, because the loss of confidence causes investors to retreat from European treasury bond markets. As a consequence, the portfolios of banks and other large investors, which retain government securities on their books, would weaken. Further capital flight from the European banking system could spark a systemic crisis, which would again heavily strain public households. And, fear of this spiraling risk would scare away investors.
To regain the citizens‘ and markets‘ trust is naturally difficult. For, the promise of abundant loan assistance is not credible as long as there is no convincing plan for reform of economic governance in EMU. The incentives for politicians to deviate from long-term objectives of economic politics are still enormous and particularly high immediately before elections. The sovereign debt crisis is founded in exactly these types of problems.
Nevertheless, the advantages that arise from a common currency area persist still today. The Euro decreased transaction costs in the single European market, which fosters trade, promotes increased production, and thereby can lead to stimulated growth and prosperity in Europe. In this respect, the Euro creates a common good for all EMU member states. However, the sustained protection of these benefits in a continuously changing global economic environment necessitates stronger budgetary discipline among member states.
We have developed a number of proposals for a stability-bound arrangement with the Euro as the common currency. Included is the realization that prosperity in Europe is only guaranteed through sustained monetary and fiscal stability as well as stability of the financial system. This stability is accordingly more difficult to achieve as more state, but also private, actors rely on assistance coming from outside. That means first of all that the principle of complete liability of each actor for its own economic decisions must become valid again in order to strengthen the responsibility for and awareness of risks in economic decisions.. Moreover, every fundamental reform that alters the European monetary union must take into account and build upon the changes that have been made in the course of battling the crisis up until this point. The hitherto existing reforms take in part the right direction, but they do not arrive at the end goal, which is to purge member states‘ excessive debt and actively discourage future undue borrowing.
Next, it is necessary also to operatively and unambiguously anchor the reforms decided upon until this point into European primary law. That includes the improvement of the legal foundations for the Sixpack and the transfer of the Treaty on Stability, Coordination and Governance to European primary law. In this respect, our proposal adopts a long-term nature. It should facilitate a reanimation of the EMU without introducing joint and several liability for public debt or any form of monetary financing at the European level. We oppose Eurobonds and well as the attempt to make the European Central Bank into a lender of last resort for the fiscal problems of member states. Principally, we suggest the following:
- The disciplinary functions of the market must be reinforced. That includes realistically reconfiguring the risk weighting of 0 percent for state securities. Private investors must take into consideration for their future plans that they will share in the restructuring of public debt.
- The reduction of public debt to a sustainable level must take precedence to reconstruct member states‘ ability to act autonomously.
- New structural deficits must be effectively prevented.
- Should a member state enter budgetary crisis, it must adopt a binding program for reforms in a timely manner that will be overseen by the Commission and the Council. If the member state is not willing or able to reform, then it must exit the EMU. In this sense, a member state’s exit from the EMU must be legally regulated. This threat of sanctions should strengthen incentives to practice budgetary discipline.
- The European Stability Mechanism should have the role of stabilizing financial markets under extreme circumstances.
- Structural reforms, not quantitative easing or further public indebtedness, must drive economic growth.
About the authors:
Christian Fahrholz is a senior researcher at the graduate school “Global Financial Markets” at the Friedrich-Schiller-University. He is also affiliated with the Chair of Economic Policy at the Friedrich-Schiller-University Jena. Former appointments include visiting professorships at Erfurt, Mannheim and Berlin.
Andreas Freytag holds a chair of economic policy at the Friedrich-Schiller-University Jena. He is also a visiting professor at the University of Stellenbosch and the Tallin University of Technology.
Christoph Ohler holds a chair for Public Law, European Law and International Economic Law at the Friedrich-Schiller-University Jena. He is spokesperson of the graduate school “Global Financial Markets”.