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Vice-President of the European Commission and member of the Commission responsible for Economic and Monetary Affairs and the Euro
Rebuilding the Economic and Monetary Union
Center for European Studies, Harvard University
25 September 2012
Ladies and Gentlemen,
I very much appreciate the opportunity to discuss the on-going economic and political transformation of the European Union with such a distinguished audience. I am glad to see that Europe and European affairs still draw such attention. After all, the news over the past few years from the old continent cannot have been exactly an inspiration for deeper European studies. Indeed, in Europe too there have been many voices expressing doubt about the future of the European Union. Some are even suggesting that the story of European integration might be reaching its final chapter.
Let me start by saying that one does better by not believing in these pessimistic cassandras. We tend to say back home that a pessimist is never disappointed; but in the end, it is those with patience and stamina who will carry the day.
This goes for Europe as well. I am bringing some better news from across the ocean. And I am particularly happy to be able to do so here at the Harvard University, which is known for its openness and strong international links, and for unique academic and scientific achievements.
In the midst of so much worrying news about the economic and political crisis in Europe, one can too easily forget that Europe is still much stronger than often perceived.
The European Union, with its more than 500 million citizens, is and will still for some time to come be the largest single economic area in the world. It counts for almost one third of global economic output. It is the largest trading partner and source of foreign investment for the US, China and many others. It is the world's leading power in development cooperation, and its soft power is a source of stability and progress in its neighbourhood and beyond. The innovation and technical advancements it generates create wellbeing far beyond the borders of the continent.
And most importantly, the European Union continues to do what it has always done best: maintaining the longest ever period of peace, freedom and prosperity in the troubled history of Europe.
To be sure, we are today witnessing an extremely fast global economic and political re-balancing between old and emerging powers. But it would be a mistake to count Europe out. The European Union is here to stay, and I believe this is good news for everyone, not just Europeans.
Ladies and Gentlemen
This is of course not to say we do not have deep problems to deal with, or that we would have already overcome the economic crisis.
Several of our Member States still face great challenges in stabilising their public finances and strengthening their competitiveness. Unemployment is at unacceptable levels in most of the 27 Member States. The return to growth will be sluggish and slow.
In the short term, we have to ensure that the financial markets are stable enough to fuel the engines of growth. We have had to create financial stabilisation mechanisms to provide liquidity to Member States that find themselves shut out of the markets, so that they have the time they need to pursue essential reforms. We have completely overhauled Europe's economic governance; that is the rules and practices for coordinating our member states' economic and fiscal policies. We have engaged in far-reaching structural reforms for growth at the European level and in individual countries. I am convinced that all this hard work will start bearing fruit in a not too distant future. Indeed, the first signs are already visible, as I will explain in a moment.
The build-up of debt, deficits and imbalances in our economies did not happen overnight, but over many years. And the rebalancing of the European economy that is now underway will inevitably still take time.
The good news is that change is happening. Across Europe, determined reforms to address long-standing weaknesses in labour, product and financial markets contribute to the successful consolidation of public finances, and help ensure lasting improvements in competitiveness in countries running current account deficits. In Italy and Spain, there is a wave of reforms going on for some time.
Although the macro-economic outlook is still bleak, there are signs that the imbalances are gradually narrowing, helped by adjusting unit labour costs.
For instance, Ireland has been able to re-access the markets earlier than envisaged. Portugal is recording stronger-than-expected export growth, which is helping to offset weaker domestic demand. And Greece has achieved more than is often recognised in terms of fiscal consolidation and structural reforms.
By the same token, countries with current account surpluses should pursue targeted structural reforms to remove unnecessary constraints on domestic demand and investment opportunities. All of Europe stands to benefit from a more rapid rebalancing of the economy.
For example, Germany has been recommended to allow wage-growth in line with productivity, to use its fiscal scope for growth-enhancing investment in education and research, and to enhance participation of women into the labour force. We have every reason to believe that Germany is going to pursue these recommendations. It is worth noting that recent wage agreements in Germany foresee average wage increases of 4.8%.
It is essential that our Member States now stay the course of sound fiscal policies and continue with structural reforms to create the conditions for investment, sustainable growth and employment.
In this context, one hears sometimes criticism of a too strict implementation of the EU's Stability and Growth Pact, and its 3% deficit-and 60% debt-ratio-thresholds. Let me make two points on this. First, the EU and euro area are collectively still breaching both thresholds, which is a major reason for why the financing of the deficit and debt has become so expensive for many Member States. Before those levels are brought on a clearly downward path, their cost of financing will crowd out possibilities for more productive and growth-enhancing use of public funds. I trust Professor Rogoff could agree that this time is not different either.
Second, the Pact is not stupid. It focuses on the structural effort of a member state to correct its excessive deficit, and thus allows a differentiation across member states according to their fiscal space and macro-economic conditions. This is guiding in our economic and fiscal policy coordination and the recommendations addressed to the member states.
To allow time for the countries affected by persistent tensions in the sovereign bond markets to enact much-needed reforms, Europe's financial backstops have been strengthened. The European Financial Stability Facility (EFSF), set up in 2010 for three years, has been providing financial assistance to Greece, Ireland and Portugal. A new, robust and permanent firewall – the European Stability Mechanism (ESM) – will become operational in October, nine months earlier than initially planned. The leaders of the euro area have committed to use the available instruments in an efficient and flexible manner.
This means, in particular, a readiness to intervene in bond markets when necessary, following a request by a Member State and subject to strict conditionality.
These financial stabilisation tools are complemented by the bold decision of the European Central Bank to introduce a scheme for Outright Monetary Transactions. This allows the ECB to buy government bonds on the secondary market, provided the Member State is covered by a programme under an EFSF/ESM instrument, active or precautionary, which allows for the possibility of primary market purchases.
To ensure that such interventions help reduce bond yields in a lasting manner, they would be available only to countries that pursue sound budgetary policies and address macroeconomic imbalances. Conditionality would be based on the EU’s country-specific recommendations adopted last July, and set out in a Memorandum of Understanding with specific policy objectives and a clear timeline.
Ladies and Gentlemen,
For the medium to long-term, we have engaged in a very far-reaching process of rebuilding Europe’s Economic and Monetary Union (EMU). We have already improved the functioning of EMU, but further changes are needed to address the weak spots of its original design. We need to strengthen the foundations of the euro, to remove all doubts as to its sustainability.
The debt crisis has shown that EMU, as it was conceived and implemented in the 1990s, was incomplete. A full monetary union has been in place for over a decade, with the European Central Bank in Frankfurt setting interest rates for the entire euro area since 1999 and euro notes and coins in circulation since 2002.
But, for a number of reasons, the same progress was not made towards building an economic union, with a corresponding level of integration among euro area countries in budgetary policies, debt issuance, financial sector supervision and so on.
To launch the work for future institutional reforms, the President of the European Council, in cooperation with the Presidents of the Commission, the Eurogroup and the ECB, presented in June a report "Towards a Genuine Economic and Monetary Union". It identified four essential 'building blocks' for further integration: (i) an integrated financial framework, (ii) an integrated budgetary framework, (iii) and integrated economic policy framework and (iv) democratic legitimacy and accountability.
On the first block, the Commission presented two weeks ago its proposals for a banking union. We propose shifting the supervision of euro area banks to the European level, to the European Central Bank. This would be subsequently combined with other steps, such as integrated bank crisis management and deposit protection.
Ensuring that bank supervision and resolution across the euro area meet high standards will reassure both the public and the markets that a common, high level of prudential regulation is consistently applied to all banks. If banks get into difficulties in the future, the public should have the confidence that ailing banks will be restructured or closed while minimizing costs for the taxpayer. This future system will help build the necessary trust between Member States, which is a pre-condition for the introduction of any common financial arrangements to protect depositors and support orderly resolution of failing banks.
We are not quite yet about to create the equivalent of the FDIC in Europe, but I cannot deny that the US arrangements have been a source of inspiration for our work. Once the single supervisory mechanism is in place, the direct recapitalisation of banks from the ESM becomes possible. Then, we will need to consider further steps towards a common resolution authority. Finally, at a later stage, a more closely integrated deposit guarantee system can be considered.
On the second and third block, or the fiscal and the economic union, the Commission will publish a blueprint for the way forward later this fall. To give an idea of how far we are willing to reach, I would like to draw your attention to the State of the (European) Union address by President Barroso on 12 September, in which he promised we’ll present a blueprint to identify the necessary tools and instruments, including Treaty changes, to complete a genuine economic and monetary union.
A fiscal union would need to rest on effective mechanisms to prevent and correct unsustainable budgetary developments in the Member States. This could in turn involve coordinated or even common – but limited – debt issuance. The guiding principle here has to be that any further mutualisation of sovereign risk would need to go hand in hand with deeper integration of budgetary decision-making, to safeguard against moral hazard and free riding.
And, obviously, such a fiscal union would require strong democratic institutions to ensure the necessary checks and balances, and the ownership of the EMU by its citizens.
Ladies and Gentlemen,
I have outlined to you the main elements of an on-going transformation of Europe. We are still at early stages of the transformation, but I hope to have made clear to you how much has already been achieved.
Yet we need to remain realistic. For example, we cannot expect the euro area to transform itself into a full fiscal union overnight. Deeper integration needs to be accompanied by strong democratic legitimacy. Far-reaching decisions need to be allowed time to be appropriately reflected upon, debated and agreed in a way that is fully legitimate, especially considering the complex democratic construction that is the European Union.
But it is clear that we have the sense of direction, and the determination to move forward and build what I have called EMU 2.0: a new, more robust and more sustainable economic and monetary union for Europe.
It is only with such common vision of a genuine and effective economic and financial union, backed by strong democratic accountability, that we will build a true stability union of responsibility and solidarity, capable of enabling sustainable growth and job creation.