SUMMARY
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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