The future of economic governance in the EU - European Union Committee Contents


The banking crisis in 2008 triggered a crisis of confidence in the financial health of Member States of the euro area. Concerns over the level of Greece's public deficit and debt in late 2009 soon widened to include other euro area countries including Ireland, Portugal and Spain. By late 2010 Greece and Ireland had accepted financial assistance from emergency liquidity funds established by the EU and euro area Member States.

The effect of the banking crisis on countries across the EU demonstrated the interconnection between the banking sector and public finances. It showed the degree to which economies in the EU, and particularly the euro area, are interdependent. In addition, however, the crisis revealed shortcomings in the architecture of the Economic and Monetary Union. An asymmetry between a centralised monetary policy and decentralised fiscal and supply-side policies, combined with a build-up of competitiveness imbalances between Member States, have left the future stability of the euro area in doubt. These problems were exacerbated by a failure of the markets, and Member States themselves, to understand the construction of the euro area. This saw the markets treating the euro area as a single entity without considering, and thus acting on, the financial health of individual Member States (for example, there was very little difference between the cost of Greek and German sovereign debt).

In response the European Commission, supported by the European Council, have put forward a series of legislative proposals that would monitor and coordinate more closely economic policies between Member States. The Commission's proposals focus on two elements: fiscal discipline (through amendments to the Stability and Growth Pact and a new Directive to reinforce domestic fiscal frameworks) and macroeconomic stability (through new mechanisms to monitor and correct macroeconomic imbalances). Most of these proposals apply to all Member States in the EU. Sanctions to enforce these measures can only be imposed against euro area Member States since the need for closer economic cooperation is greater in the euro area.

Although not the full fiscal union in the euro area that some of our witnesses suggested was necessary, the design of these measures is a step in the right direction. Closer economic cooperation can help foster greater economic stability for all Member States in the EU, but particularly for those in the euro area. The proposals relating to fiscal discipline and cooperation should make it easier for Member States in the euro area to arrive at a collective fiscal stance that stands as an equal to a centralised monetary policy. Likewise, the proposals for greater macroeconomic surveillance and coordination should help detect and address excessive imbalances which have the potential to destabilise the euro area. We do, however, stress that the proposals should not result in countries with a current account balance in surplus being asked to make adjustments which will harm their global competitiveness.

We have concerns, however, about the likelihood of these proposals being successfully implemented. Previous attempts to enforce fiscal discipline in the euro area through the Stability and Growth Pact proved ineffective when it became clear that sanctions would not be imposed for breaches of the Pact. Now that they have a better understanding of the construction of the euro area the markets will play the key role in restraining lax fiscal behaviour by Member States. However, if these new proposals for fiscal discipline and macroeconomic stability are to have any chance of success it is essential that the political authorities of the EU must take them seriously and ensure that they are adhered to. Where necessary they must be reinforced through sanctions that are credible and appropriate. The political resolve of Member States will determine whether these measures to increase the long-term stability of the EU, and the euro area in particular, are successful. We remain sceptical that this will be the case.

Supplementing the Commission's proposals will be a permanent crisis resolution mechanism, created and funded by euro area Member States. We support the establishment of the European Stability Mechanism. In particular, we welcome the inclusion of collective action clauses which will establish a formal mechanism to restructure sovereign debt. This is essential to ensure that the markets act to discipline Member States with irresponsible fiscal policies.

Although the European Stability Mechanism will be compulsory only for Members of the euro area, we believe that there may be times, as with Ireland, when it will be in the UK's interests to participate in financial assistance to Member States in difficulties. We therefore welcome proposals to allow Member States outside the euro area to contribute on an ad hoc basis when they wish to do so.

The problems in the euro area have, so far, been contained and no Member State has yet defaulted on its sovereign debt. However, the threat remains and the period until the new crisis resolution mechanism is introduced in 2013 is likely to be fraught despite reassurances from EU leaders. In particular, the willingness of taxpayers in countries subject to the most acute pressures to continue to shoulder the burden of adjustment cannot be taken for granted. If economic growth does not ease this burden they may be tempted to demand that bond-holders share the pain of adjustment, a prospect that could result in fresh financial turmoil. A focus on growth, in addition to fiscal discipline, is therefore essential.

The proposals covered in this report are well on their way to being adopted. However, we note that a number of issues remain unresolved, including: whether or not the time has come for euro bonds to be issued by the euro area as a whole rather than by individual members; the linkages between the new European Systemic Risk Board and the Commission's proposals on macroeconomic surveillance; and the possibility of developing further the proposed permanent crisis resolution mechanism into a European Monetary Fund.

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