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.