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European Commissioner for Economic and Monetary Affairs
Is the euro saved for good?
The Brookings Institution
Washington, 14 April 2011
Ladies and Gentlemen, Justin, Dan,
Thank you for your kind invitation to speak at Brookings on a topic that has kept me very busy over the past year! The financial crisis has served as a severe stress test for the euro-area economy. Many commentators have claimed that our single currency has failed and have predicted a break-up of the euro-zone.
It is certainly true that we have lived through a period of serious stress. But the euro's critics are wrong to claim that this will lead to its failure or break-up. The euro area will not only survive, but is coming out of the crisis stronger than before, once we have completed the ongoing reforms and built a new economic and financial architecture.
This key message is supported by five main arguments:
1) We have shown our capacity to act and to contain financial turbulence, and have created effective financial stability mechanisms;
2) We are implementing a very systematic program of fiscal consolidation, and undertaking unprecedented structural reforms;
3) We have identified the key systemic weaknesses of EU economic governance and are addressing them in a way that will profoundly change the policy-making landscape in the European Union;
4) We are already seeing results in terms of economic recovery and increasing confidence; and
5) The benefits and value of the euro for Europe are far larger and more significant than often appreciated by some of the euro's critics.
Ladies and Gentlemen,
Less than twelve months ago, Greece was about to default. We discovered that the country's public finances were in much worse state than earlier known or assumed. While it took some time to recognize what was necessary and get our act together, we did so decisively. The euro area, together with the IMF, approved a €110 billion conditional rescue package for Greece in early May.
Only a week later we created a three-year financial stability mechanism with a community arm (EFSM) and an intergovernmental arm (EFSF), all in all with € 500 billion of resources.
When, last November, Ireland's banking sector was about to implode with devastating consequences for its public finances, we were able to activate the new mechanism very swiftly. Last week, Portugal requested EU-IMF financial assistance, and we can expect a support programme to emerge in a matter of a few weeks.
The turbulence in sovereign debt market is not over yet. But we are quite confident that, with the Portuguese programme, we will have contained the problem. It is noteworthy that the Portuguese request did not affect spreads in neighbouring Spain. Indeed, as has been almost universally been recognized now, latest by the IMF yesterday, Spain has de-coupled from the other three countries.
While I cannot yet say "mission accomplished", I am increasingly confident that we are entering into the endgame of the crisis management phase.
The European financial stability mechanism and facility are in force until mid-2013. After that they will be replaced by a permanent European Stability Mechanism (ESM), which will safeguard financial stability in the euro area. It will contain three elements: financial assistance, an adjustment programme and a possibility for private sector involvement, based on an analysis of debt sustainability.
What has been achieved with these arrangements? By providing conditional financial assistance to soon three EU Member States, we have prevented financial chaos in Europe, which could have had potentially serious global repercussions. Preventing a European Lehman has not been a simple task, with 27 fiscal authorities and 11 central banks – we never had the genius of Alexander Hamilton to draw on, like you did, unless you count Jacques Delors for this too – but the task has nevertheless been accomplished.
It is essential to note that it is not just financial assistance that is involved. The assistance is strictly conditional. A Member State which makes a request has to put its public finances in order and take very difficult – but equally necessary and often overdue – structural reforms in the labour markets, pension systems, competition policy etc. The assistance packages are instruments for reforming some of the weakest EU economies.
This takes me to my second point. Europe is addressing its public finance challenges with vigour, led by the most vulnerable countries.
The crisis has increased government debt in the euro area by some 20 percentage points – to close to 90 % of GDP by 2012, on average. This is somewhat lower than the comparable figure for the US, which would include states and local governments. But we strongly believe that immediate action is needed to put debt on a declining path – not only on average but in every single Member State. And that is precisely what we are doing. This year every EU Member State will reduce its budget deficit, and the consolidation is set to continue for years to come.
Similarly, structural reforms are now being implemented with a new sense of urgency. This is key for unleashing higher potential growth in the longer-term, and for raising employment prospects. Perhaps the best example is Spain, where the labour market, the pension system, and the banking system are being reformed with previously unseen determination, which has been appropriately recognised by the "market" and e.g. by Chinese, Russian and Norwegian sovereign wealth funds.
Ladies and Gentlemen,
Yet from the euro area perspective, the most significant thing that the crisis brought about is a complete overhaul of European economic policy governance. It is based on the following identification of the issues.
Even if the EU has had what we call the Stability and Growth Pact to guard against imprudent fiscal policies of individual Member States, the Pact has not been sufficiently effective or strict enough. It has allowed countries to run high debt levels, thus making them vulnerable to adverse shocks. Greece is, of course, the most acute example.
Also, we have paid only very little, if any, attention in our policy coordination to broader macroeconomic imbalances, such as weak competitiveness, high current account deficits or credit and asset price bubbles. Nevertheless, these can cause severe problems not only for the Members State in question but also for the rest of the euro area or the Union as a whole. Ireland and Spain are cases in point.
Finally, when even rules have existed, they have not been enforced with rigour.
Now, all this is changing. We are about to put in place a comprehensive reform of economic governance in the summer. What will it mean?
First, in order to avoid the build-up of excessive deficits and debt, we will strengthen the Stability and Growth Pact. We will make the adjustment towards a medium-term budgetary objective operational and binding. We will also revive the neglected debt criterion of the Pact and pay more attention to debt sustainability.
Second, we will broaden economic surveillance to identify and address macroeconomic imbalances and divergences in competitiveness. When unsustainable developments are identified on the basis of a scoreboard, in-depth country analysis and country-specific recommendations will follow, initiated by the Commission and decided by the Council.
Third, to prevent unsustainable economic policies by Member States, we will introduce stronger incentives and sanctions. These will kick in at an earlier stage of the surveillance process and be gradually tightened, unless corrective action is taken by the Member State concerned. Equally important, we want to make the consequences of irresponsible behaviour more automatic - we call this semi-automaticity - and thus less subject to political deliberation, i.e. wheeling and dealing.
One very important change has already been implemented. From this year on, the process of EU economic surveillance is conducted in the first half of the year through the so-called "European Semester".
It will enable consistent policy guidance early enough, so that it can be taken into account by Member States in the formulation of the national budgets for the following year. Right now we are in the process of doing this for the 2012 budgets.
With these changes, we are recasting our policy-making in an essential way. Particularly in the euro area, but also more broadly in the EU, economic policy-making will become much more rules-based and will take much better into account the spill-over effects to other Member States. Neither the European Union nor the euro-area will become a federal system, but they will be much more than a sum of its member countries through deeper integration and reinforced economic governance.
Many Americans think EMU stands for 'European Monetary Union', when in fact it means 'Economic and Monetary Union'. What we are doing in Europe is strengthening our economic pillar – the E of EMU!
Ladies and Gentlemen,
Let me now come back to the specific role of the euro. The economic rationale of the euro was, on the one hand, to enhance the functioning of the markets in a very integrated economic system and, on the other hand, to provide stability. It has done both.
The euro has substantially helped cross-border trade in both goods and services in Europe.
It has also been a stabilising factor. It has prevented the all-too-familiar currency crises with sky-high interest rates, as well as eventual devaluations of the fixed-but-adjustable systems like the EMS. With the types of shocks we have experienced since August 2007, an EMS system would have been highly destabilising and would have most likely broken down.
Of course, the single currency made it easier for some Member States to end up in unsustainable credit booms and unsustainable private and public debt levels. Similarly, the adjustment after the bursting of the bubble is probably more demanding in the absence of exchange rate flexibility.
But one should not exaggerate these aspects. The UK and many so-called new Members States managed to create much bigger credit bubbles, banking crises and public finance problems than many prudent euro area Member States. And if you look at the speed at which Irish unit labour costs have adjusted, the exchange rate adjustment alone does not seem decisive.
While the reforms which I have briefly described benefit the Union as a whole, they are especially important for the euro-area. Therefore, the coordination must be closer among these countries than the rest, and for instance the sanctions for bad behaviour must be tougher.
Ladies and Gentlemen,
Macroeconomic developments over the past year have produced rather strong evidence that our policies are working, in spite of a very difficult starting point. A recovery is underway. While it has been export-led up to now, domestic demand has started to contribute increasingly. Moreover, the labour market is gradually improving.
No doubt, Europe still faces significant economic challenges. Global competition has not diminished in the years of economic crisis; rather the opposite. Unemployment is still unacceptably high in many parts of Europe. Our populations are aging rapidly, and we face the challenge of securing our energy supplies in a safe and environmentally responsible manner. And several new downside risks to the global economy have emerged recently, including the disaster in Japan and higher energy and commodity prices.
But let me be clear, the euro is not on the list of problems. Instead, it is an essential part of the solution. It contributes to growth by enhancing cross-border economic activity and competition, and is essential for macro-economic stability.
Lastly, let me recall that the euro is not just a technical monetary arrangement, but rather the core political project of the European Union. As such, it is a symbol of our political will and determination to work together for our common good.
That is a further reason why it is worth taking Europe seriously when we say that we are ready to do whatever it takes to defend the euro and financial stability in Europe.
Thank you for your attention.