House of Lords - 'Genuine Economic and Monetary Union' and the implications for the UK

'Genuine Economic and Monetary Union' and the implications for the UK - European Union Committee Contents

'Genuine Economic and Monetary Union' and the implications for the UK

CHAPTER 1: 'GENUINE ECONOMIC AND MONETARY UNION'—STICKING PLASTER OR MIRACLE CURE?

1. The proposals for European 'Genuine Economic and Monetary Union' first emerged as a key plank of the EU institutions' attempts to respond to the series of crises to hit the eurozone in the wake of the 2008 financial crisis.[1] In particular, the links between sovereign states and their seriously indebted banking sectors—the so-called 'doom loop'—combined with the threat of cross-border contagion, threatened to overwhelm the eurozone.

2. When it was revealed by the IMF in the summer of 2012 that there was a near €40 billion hole in the balance sheets of Spanish banks, EU leaders recognised that urgent action needed to be taken. The President of the European Council, Herman Van Rompuy, prepared a report for discussion at the June 2012 European Council. The report, entitled Towards a Genuine Economic and Monetary Union, envisaged a "stable and prosperous EMU based on four essential building blocks":

(1) An integrated financial framework to ensure financial stability in particular in the euro area and minimise the cost of bank failures to European citizens. Such a framework would elevate responsibility for supervision to the European level, and would provide for common mechanisms to resolve failing banks and guarantee customer deposits;

(2) An integrated budgetary framework to ensure sound fiscal policy-making at the national and European levels, encompassing coordination, joint decision-making, greater enforcement and commensurate steps towards common debt issuance. It was envisaged that this framework could also include different forms of fiscal solidarity;

(3) An integrated economic policy framework which has sufficient mechanisms to ensure that national and European policies are in place that promote sustainable growth, employment and competitiveness, and are compatible with the smooth functioning of EMU;

(4) Ensuring the necessary democratic legitimacy and accountability of decision-making within the EMU, based on the joint exercise of sovereignty for common policies and solidarity.[2]

3. The Council invited the Four Presidents to develop by the end of 2012 "a specific and time-bound road map for the achievement of a genuine Economic and Monetary Union."[3] A final report was produced in December 2012, in preparation for that month's European Council.[4] The Commission published its own, complementary document, A Blueprint for a Deep and Genuine Economic and Monetary Union: Launching a European Debate, in November 2012.[5] Both papers set out the measures that needed to be taken in the short, medium and long term. The main elements of 'Genuine Economic and Monetary Union', and the proposed timeframe for its implementation, are set out in Boxes 1 and 2 below.

BOX 1

Main elements of 'Genuine Economic and Monetary Union'

Notwithstanding some differences of detail between the Four Presidents' Report and the Commission Blueprint, the principal elements of 'Genuine Economic and Monetary Union' are as follows:

(1) Banking Union, comprising:

(a) Centralised bank supervision, led by the ECB (since agreed);

(b) A Single Resolution Mechanism incorporating an effective common backstop, but limiting the exposure of taxpayers;

(d) Common deposit insurance.

(2) Fiscal union:

(a) Mechanisms for better discipline in, and coordination of, fiscal policy, building on the measures already agreed in the last three years;

(b) A new fiscal capacity for the eurozone: initially to provide targeted but temporary support for countries undertaking structural reforms; subsequently becoming an instrument to help in dealing with country-specific economic shocks through a centrally-managed insurance system;

(c) The possible establishment of forms of debt mutualisation, including the eventual introduction of a Eurobond available to all participating Member States, which would be jointly and severally guaranteed.

(3) Closer integration of economic policies intended to promote sustainable growth, competitiveness and employment and improving the resilience of the economy to shocks. This would include:

(a) Further efforts to complete the Single Market, including by stimulating labour mobility across borders and possibly greater tax harmonisation;

(b) A reinforced framework for ex-ante coordination of major policy reforms, notably those affecting the supply-side of the economy;

(c) Contractual relationships between Member States and the Commission on economic strategies, with accountability to both the European Parliament and national parliaments.

(4) Enhancement of democratic oversight of pooled economic policies.

BOX 2

Proposed timescale for 'Genuine Economic and Monetary Union' (as proposed in late 2012)[6]

Two distinct timetables were put forward, with the final version of the Four Presidents' Report suggesting three phases, two of which would be completed by the end of 2014, and the Commission suggesting short, medium and longer term developments of EMU.

Under the Four Presidents' proposals, an initial phase was to be completed by the end of 2013, and was expected to ensure fiscal sustainability and break the damaging links between banks and sovereign debt. A second phase, foreseen for 2013 and 2014, was supposed to complete the integrated financial framework and to put in place mechanisms for stronger policy coordination. In a third phase, beyond 2014, the plan was to improve the resilience of EMU by creating a "shock-absorption function at the central level".

The Commission timetable, which included much of the first two phases of the Four Presidents' proposals in its first stage, was as follows:

In the short term (within six to 18 months), completion of the Banking Union and—once an agreement on the Multiannual Financial Framework has been reached (which it was in June 2013, following the assent of the European Parliament)—create a "convergence and competitiveness instrument" within the EU budget to support the timely implementation of structural reforms. This support could be based on commitments set out in "contractual arrangements" concluded between Member States and the EU institutions.

In the medium term (18 months to five years), a further strengthening of the collective conduct of budgetary and economic policy—including tax and employment policy—could go hand-in-hand with a dedicated fiscal capacity for the euro area, relying on own resources and providing sufficient support for important structural reforms in large economies under stress. Short-term Eurobills or a Debt Redemption Fund, subject to strict conditionality, could also be considered.

In the longer term (beyond five years), based on the adequate pooling of sovereignty, responsibility and solidarity at the European level, it should be possible to establish an autonomous euro area budget providing for a fiscal capacity for the EMU. A deeply integrated economic and fiscal governance framework could allow for the common issuance of public debt. This could be the final stage in EMU.

Diagnosing the problem

4. The concept of 'Genuine Economic and Monetary Union' is based on the premise that the existing Economic and Monetary Union was somehow incomplete or deficient. The flaws in EMU's architecture, predicted by some at the outset of the single currency project, are now widely acknowledged, including by the EU institutions. The Commission has drawn attention to the following deficiencies:[7]

· The accumulation in some eurozone Member States of large private and public debts, losses in competitiveness, and macroeconomic imbalances, which rendered them vulnerable when the financial crisis struck. This led to significant contagion effects across the eurozone once the sovereign debt crisis developed.

· EMU's unique status amongst monetary unions in combining a centralised monetary policy with decentralised responsibility for most economic policies and with no centralised fiscal policy function or fiscal capacity (i.e. a federal budget). This meant that the rules governing the coordination of budgetary policies, as set out in the Stability and Growth Pact (SGP), were of vital importance.[8] Yet the SGP was insufficiently observed by the Member States and lacked robust mechanisms to ensure sustainable public finances.

· The coordination of national economic policies relied on soft instruments —peer pressure and recommendations—and had a limited impact on the actions of individual Member States. The approach was too weak to counter growing gaps in competitiveness and growth between Member States. Little consideration was given to the euro area-wide spillover effects of national measures.

· The global easing of inflationary pressure in the late 1990s led to a rapid and sustained expansion in the money supply. This resulted in a global excess of liquidity and ultimately a severe mispricing of risk of both private and public assets. The reliance by banks on national bonds for their open market operations resulted in strong yield convergence, considerably limiting market discipline despite differences in national budgetary performance. Euro area economies in a cyclical expansion and with relatively high inflation rates tended to enjoy low or even negative real interest rates. This led to significant credit expansion in some countries, fuelling significant housing bubbles.

· The inception of EMU saw a sharp acceleration in the pace of financial integration. While this created opportunities, it also accelerated the transmission of shocks across national borders. Yet the responsibility for prudential supervision and crisis management remained predominantly at the national level.

· The lack of an integrated EU-level framework and a mechanism to mutualise the response to risks coming from the banking sector resulted in powerful and damaging negative loops (often referred to as a 'vicious circle') between the banking system and sovereign states. This fuelled the debt crisis further. As a result, some Member States were excluded from market financing and there has been a risk of contagion affecting the euro area as a whole. The absence of an effective mechanism to provide liquidity to Member States in distress, and thus to manage contagion risk and to safeguard euro area financial stability, emerged as a clear inadequacy in the crisis management arrangements.

5. Our own analysis, as set out in our March 2011 report on The Future of Economic Governance in the EU, was that:

6. In light of subsequent experience, other problems have been revealed, including a lack of crisis management capability or means of dealing with sovereign debt and bank resolution, and a range of legitimacy and political accountability challenges. In particular, the toxic link between banks and sovereign states was accompanied by retrenchment of financial activity within national boundaries, not least because many banks did not want to be exposed to risks posed by weak sovereign states as well as to credit risk. This created the pernicious 'doom loop' from which several of the most affected Member States struggle to escape. The Commission and EU Member States have long acknowledged the problem, but as yet have failed to reach agreement on the decisions necessary to break the link: in December 2013 they were roundly criticised by European Central Bank (ECB) President Mario Draghi for failing to do so.[10]

The sticking plaster approach

7. The Commission has been at pains to point out that significant steps have already been taken to seek to address the consequences of the crisis, some of which apply to all 28 members of the EU, some only to the eurozone and some to eurozone members plus others who choose to 'opt-in'. These are set out in Box 3 below.

BOX 3

Measures already taken to address the crisis

(1) Economic policy surveillance:

(a) The Six-pack, concluded in November 2011, comprising five regulations and a directive, which are designed to provide for tighter discipline on public finances. Provisions include the recasting of the Stability and Growth Pact and an obligation to introduce stronger fiscal rules in national policy frameworks, together with a new mechanism to curb macroeconomic imbalances;

(b) The Two-pack, concluded in May 2013, consisting of two regulations applying only to the euro area, ensuring closer oversight of the public finances of euro area members. The first round of scrutiny of national budgets was conducted in autumn 2013;

(c) The European Semester and the euro-plus pact, the latter with 23 signatories, intended to promote better economic policy;

(d) The Fiscal Compact, designed to reinforce the governance of fiscal and economic policies, incorporated in the Treaty on Stability, Coordination and Governance (TSCG), signed by 25 Member States (subsequently also by Croatia).

(2) Financial regulation and supervision (broadly based on the recommendations of 2009 report of the high level group chaired by Jacques de Larosière):[11]

(a) CRD IV, the package which transposes—via a Regulation and a Directive—the new global standards on bank capital (commonly known as the Basel III agreement) into the EU legal framework;

(b) European Supervisory Authorities covering, respectively, the banking, insurance and securities sectors. These so-called 'level 3' agencies were given greater powers as a result of the reforms launched in 2009;

(c) European Systemic Risk Board (ESRB), charged with assuring 'macroprudential supervision'—the interplay between macroeconomic developments, especially budgetary policies, and financial stability.

(3) Crisis resolution funding mechanisms, all of which were set up to provide resources for bailing out countries in difficulty:

(a) The creation of the European Financial Stability Facility (EFSF) (limited to eurozone and temporary), agreed in May 2010, with a nominal capacity of €440 billion and backed by the governments of the eurozone;

(b) European Financial Stabilisation Mechanism (EFSM) (EU-wide and temporary), also agreed in May 2010, with a capacity of €60 billion and backed by the EU budget;

(c) European Stability Mechanism (ESM) (eurozone and permanent), signed in February 2012 and based on a limited amendment to Article 136 TFEU, and a separate treaty, with a capacity of €500 million and backed by participating Member States. It was inaugurated in October 2012. The ESM obtains its funds by issuing bonds and is obliged by the Treaty provision to impose strict conditionality on any loans it makes to Member States.

(4) Expanding the role of the ECB:

(a) Securities Market Programme through which the ECB purchased the debt of Member States on the secondary markets, but not directly from national treasuries;

(b) Access to Long-Term Refinancing Operations (LTROs) opened to banks which used them to ensure liquidity. The facility enables banks facing funding problems to borrow directly from the ECB in what is, in effect, lending in the last resort by the ECB;

(c) The offer of Outright Monetary Transactions (OMTs) through which the ECB would purchase unlimited amounts of national debt on the secondary markets, provided that the country in question had agreed to a reform programme;

(d) ECB President Mario Draghi's July 2012 commitment to "do whatever it takes" to save the euro;

(e) Participation, alongside the IMF and the Commission, in 'Troika' missions which oversee the adjustment programmes of the countries which have received a bailout (Greece, Ireland, Portugal and Cyprus);

(f) New supervisory function within the Single Supervisory Mechanism.

8. Taken as a whole, this represents a considerable achievement. Nevertheless, it was a paradox that the reforms were gradually bringing about a new architecture of economic governance, but often appeared piecemeal. Indeed, the whole process of governance reform has been a mix of crisis management and longer-term recasting of the system. The 'Genuine Economic and Monetary Union' package is itself a reflection of this. Whereas the proposals for an integrated financial framework, or Banking Union, are acknowledged as a pressing priority to ensure the stability of the banking sector, many of the proposals for fiscal union and economic integration can be seen as longer-term, or even idealistic, objectives. Whether such long-term steps are either politically realistic or strictly necessary to guarantee the stability of the eurozone has been the subject of considerable debate.

9. A contributory factor to the apparent ad hoc approach is the way in which the impetus for reform has ebbed and flowed in line with the intensity of the crisis at any given time. As the pressure from financial markets eased (aided in particular by Mario Draghi's welcome commitment to "do whatever it takes" to save the euro[12]), the air escaped from the ambitious 'Genuine Economic and Monetary Union' balloon. There was and remains a tangible sense of lost momentum, despite the renewed urgency to establish a Banking Union following the Cyprus crisis, which came to a head in March 2013 after many months of uncertainty.[13]

10. This loss of momentum is also a reflection of the ambition of the 'Genuine Economic and Monetary Union' project. Given the political sensitivities involved, many Member States were reluctant to move as far and as fast as the EU institutions recommended, with the result that less has been agreed than the Commission and the Four Presidents had originally envisaged. As Box 4 below outlines, the 'Genuine Economic and Monetary Union' agenda has been continually buffeted by events.

BOX 4

Key events since June 2012[14]

June 2012:

· Spain requests financial support for the recapitalisation of its banks after the IMF publishes estimates of an aggregate capital shortfall of €37 billion on the most pessimistic assumptions;

· Renewed pressure on Spanish and Italian sovereign bond spreads;

· Elections in Greece result in the formation of a new coalition government;

· European Council calls for roadmap towards 'Genuine Economic and Monetary Union' and agrees a Compact for Growth and Jobs.

July-August 2012:

· ECB President Mario Draghi's commitment to "do whatever it takes" to save the euro calms markets.

September 2012:

· ECB announcement of OMTs reinforces commitment to the euro and results in a significant easing of sovereign bond spreads;

· German Constitutional Court decision allows ratification of the ESM Treaty and the Treaty on Stability, Coordination and Governance (TSCG).

October-November 2012:

· ESM Treaty (which formally spells out how the new mechanism will operate and establishes the financial vehicle for disbursing funds) is ratified and the ESM is able to start operating;

· Cyprus requests a bailout in light of the worsening problems in its banking sector, but no agreement is reached on how to proceed and a decision is deferred;

· Publication of the Commission's Blueprint for a Deep and Genuine Economic and Monetary Union.

December 2012:

· Publication of the Four Presidents' final report on Genuine Economic and Monetary Union;

· Italian Prime Minister Mario Monti announces his resignation, triggering fresh elections. There is limited market reaction;

· European Council agrees roadmap towards 'Genuine Economic and Monetary Union'.

January-February 2013:

· Indecisive Italian election results lead to deadlock in forming a new government;

· Cypriot problems deepen: A presidential election results in a change in government.

March 2013:

· Commission consultation documents on Convergence and Competitiveness Instrument and on closer coordination of economic policies are published;

· Cyprus bailout agreed after banks suspend access to accounts and capital controls are imposed to prevent an outflow of money.

April-May 2013:

· Italian coalition government led by Enrico Letta takes office;

· 'Two-pack' regulations to reinforce budgetary discipline are formally enacted.

June-August 2013:

· Negative reactions in some Member States to country-specific recommendations in the European Semester;

· Euro area returns to weak economic growth.

September 2013:

· German elections result in return of CDU as largest party: Angela Merkel remains as Chancellor pending outcome of coalition negotiations.

October-November 2013

· First Commission scrutiny of national budgets under the Two-pack regulations;

· Single Supervisory Mechanism formally approved;

· ECB asset quality review launched.

December 2013:

· German CDU/CSU/SPD[15] coalition government led by Angela Merkel takes office;

· Council agreement on Single Resolution Mechanism.

January 2014:

· Latvia becomes eighteenth member of eurozone;

· European Banking Authority publishes the main features of the stress tests on banks to be conducted later in 2014.

February 2014:

· In a split decision, the German Constitutional Court finds that the OMTs programme may be incompatible with primary law (i.e. the EU Treaties), but refers the case to the Court of Justice of the European Union for a definitive interpretation of the relevant EU law.

11. The focus of concern has also shifted. The period since June 2012 has been characterised by:

· A calming of the financial markets since Mario Draghi's commitment to "do whatever it takes" to save the euro;

· Anaemic, stagnant or negative growth in several eurozone Member States. The eurozone as a whole endured a double-dip recession, only returning—just—to growth in the second quarter of 2013;

· Continuing high unemployment (in particular youth unemployment) in countries such as Spain, reaching a peak across the eurozone of 12.2% in September 2013 and still rising in countries such as Italy;

· Increased disparities between eurozone members: today, French unemployment is more than double that of Germany, having been the same as recently as the middle of 2008;

· Falling inflation rates, prompting anxiety about the risks of a prolonged period of disinflation, or even deflation, leading to a Japan-style "lost decade" of growth.

12. As a result, the terms of debate have shifted from tackling deficits to growth and job creation. There is a widely held view that the focus on deficits is constraining growth by enforcing a eurozone-wide contraction in demand. The Commission appeared to acknowledge this when it referred in the Annual Growth Survey for 2013 to "growth-friendly fiscal consolidation".[16] Some softening of its position was apparent in the marginal extension for some Member States in the deadlines for dealing with excessive deficits.[17] There are also growing calls for Germany, as the largest Member State (and given its substantial budget surplus), to seek to stimulate eurozone demand. Critics of German policy argue that its insistence on a so-called 'austerity agenda' threatens to thwart any hope of economic recovery and places the democratic process itself in jeopardy as extremist parties seek to transform political disenchantment into electoral support. The German response is to argue that its surplus is falling, and that measures to boost German demand would in any case be unlikely to help other eurozone countries.

13. Much argument has focussed on the treatment of legacy debts. Member States under the most economic pressure have stressed that such losses need, to a greater or lesser degree, to be mutualised so as to place the eurozone on a stable footing. Germany in particular has called on Member States suffering from excessive deficits to put their own affairs in order first by undertaking structural reforms to improve their competitiveness.

14. Such debates touch directly on several elements of the 'Genuine Economic and Monetary Union' proposals. Much of what is proposed is either highly contentious, politically unrealistic, or both. Some of the proposals put forward by the Commission are, in addition, not necessary to achieve the goal of a stable Economic and Monetary Union but derive instead from an integrating agenda. For these reasons, several of the 'Genuine Economic and Monetary Union' proposals appear to have been postponed indefinitely or quietly dropped, while others are likely to proceed only on a less ambitious scale than originally proposed. As this report sets out, the original vision for Banking Union has only been partially fulfilled, while the prospects of agreement on the most contentious elements of the other pillars, such as a eurozone budget and debt mutualisation, are—as things stand—remote.

15. The asymmetry between a centralised monetary policy and decentralised fiscal and structural policies remains a fundamental flaw in EMU. This shortcoming was pointed out by many at the outset of the single currency project, but there was little political will to do anything about it. Instead, national central banks and regulators stood by while widespread mispricing of risk led to excessive borrowing in certain countries, most notoriously Greece. The mispricing of public debt may have been due in part to a false assumption by investors that there would be some degree of solidarity or ultimate common responsibility for governmental borrowing within the eurozone. The effect of this borrowing was to finance an expanding current account deficit in many countries which itself reflected a steady decline in their relative competitiveness. The outbreak of the financial crisis led to a crisis of confidence in the public debt of Greece, Portugal and to a lesser degree Italy, and in the real estate market and its principal lenders in Spain and Ireland. Because the obvious need of Spain and Ireland (and later of Cyprus) to recapitalise their banks was clearly beyond the capacity of these governments alone, a crisis of confidence in these countries' public debt was rapidly engendered. The resulting vicious circle linking banks and sovereign states is a defining symptom of the eurozone crisis.

16. The Commission has now acknowledged the flaws in Economic and Monetary Union. Yet there remains a clear conflict between the steps that are economically necessary to secure the eurozone and those that are politically realistic. Key EU players, notably the Commission, the ECB, and Germany, have different priorities. Thus while the political commitment to maintaining the single currency is as strong as ever, there is a continuing failure to agree the steps necessary to address its flaws. The end result is what was described to us as "the euro continuing as an injured patient with a massive sticking plaster in the form of bailouts."[18] Whether the 'Genuine Economic and Monetary Union' proposals form a realistic basis for overcoming such conflicts is a matter of considerable doubt.

A case for treaty change?

17. A further fundamental obstacle to addressing these flaws is the need for treaty change. In its Blueprint the Commission stated that, while some of the elements of 'Genuine Economic and Monetary Union' could be adopted within the limits of the current Treaties and thus could progress in the short to medium term, others would require modifications of the current Treaties and new competences for the Union, and could therefore only be completed in the long term.[19]

18. Specifically, the Commission acknowledged that the following proposals would require treaty change:[20]

· More intensive EU control of national budgetary policy, for example by setting up a European right to require a revision of national budgets in line with European commitments;

· Greater coordination on tax policy in the euro area;

· Moves towards a proper fiscal capacity, in particular if it provided for the EU level to borrow and thus to act in a demand stabilising manner;

· The establishment of a Debt Redemption Fund;

· Ensuring that there was appropriate democratic legitimacy and accountability of decision-making.

Further details of those elements of 'Genuine Economic and Monetary Union' which are likely to require treaty change are set out in Table 1 below.

TABLE 1

The timescale and legal form of the 'Genuine Economic and Monetary Union' proposals

Measure	Anticipated timing	Legal form
Banking Union, comprising:	Short term for initial stages, longer term to be completed	Secondary legislation and limited treaty change
i) Centralised bank supervision, led by the ECB	Agreement finalised in October 2013	Secondary legislation
ii) A Single Resolution Mechanism incorporating an effective common backstop, but limiting the exposure of taxpayers	Council agreement reached in December 2013 on a limited mechanism. Trilogue negotiations continuing	Secondary legislation
iii) An operational framework to enable the European Stability Mechanism to be used for direct bank recapitalisation	Agreed in principle, details to be elaborated	Limited treaty change to Article 136; separate intergovernmental ESM treaty
iv) Common deposit insurance	In abeyance	Uncertain
Fiscal union	Mix of short, medium and long term	Initially, secondary legislation and intergovernmental treaty
Mechanisms for better discipline in, and coordination of, fiscal policy, building on the measures already agreed in the last three years	Already enacted through a succession of measures in 2011, 2012 and 2013. Implementation being tested	Secondary legislation and Treaty on Stability, Coordination and Governance (TSCG)
A new fiscal capacity for the eurozone: initially to provide targeted but temporary support for countries undertaking structural reforms; subsequently becoming an instrument to help in dealing with country-specific economic shocks through a centrally-managed insurance system	Proposals tabled in March 2013 for Convergence and Competitiveness Instruments (CCI) and discussed at December 2013 European Council; pushed back to October 2014	Initially, TSCG; more extensive permanent mechanism likely to require new treaty base
The possible establishment of forms of debt mutualisation, including the eventual introduction of a Eurobond available to all participating Member States, which would be jointly and severally guaranteed.	In abeyance	Likely to require a treaty base, but uncertain whether it would be full, limited or separate intergovernmental treaty
Closer integration of economic policies intended to promote sustainable growth, competitiveness and employment and improving the resilience of the economy to shocks	Already partly realised through macroeconomic imbalances procedure, Two-pack and coordination provisions for deeper policy coordination agreed in 2011-2013	Initially, secondary legislation and TSCG
Further efforts to complete the Single Market, including by stimulating labour mobility across borders and possibly greater tax harmonisation	Continuing	Secondary legislation
A reinforced framework for ex-ante coordination of major policy reforms, notably those affecting the supply-side of the economy	Commission communication tabled March 2013	TSCG and secondary legislation
Contractual relationships between Member States and the Commission on economic strategies, with accountability to both the European Parliament and national parliaments	Proposals tabled in March 2013 for CCI and discussed at December 2013 European Council; pushed back to October 2014	Uncertain
Enhancement of democratic oversight of pooled economic policies	Longer term	Outside scope of present inquiry

19. Treaty change is a highly sensitive political issue. The history of EU referendums in countries such as France or Ireland, coupled with the high levels of political instability seen across much of the EU, suggests that popular approval could not be guaranteed. As a result, elements of 'Genuine Economic and Monetary Union' have been specifically designed to avoid the need for treaty change. This is notably the case in relation to Banking Union. This begs the question whether the proposals put forward will be sufficient to tackle the flaws they are designed to address.

20. One potential trigger for treaty change could be the outcome of the continuing legal investigation into the legality of the ECB's programme of Outright Monetary Transactions (OMTs). In a long-anticipated judgment, on 7 February 2014 the German Constitutional Court found that, subject to the interpretation by the Court of Justice of the European Union, the programme was "incompatible with primary law", because it "does not appear to be covered by the mandate of the European Central Bank". If so, that would create an obligation on the German authorities to refrain from implementing the OMT decision and a duty to challenge it. However, it added that, if the OMT decision were interpreted restrictively, it could be lawful. It therefore referred the questions to the Court of Justice of the European Union for a definitive interpretation of the relevant EU law, following which the German Constitutional Court will consider the implications.[21]

21. There is widespread recognition that some treaty change is necessary to underpin the scale of reforms needed to address EMU's flaws. But some of what the Commission proposes goes beyond what is strictly necessary to shore up EMU. Treaty change is both difficult to achieve and an unpredictable process. Instead, there has been a clear preference to look for ingenious, and at times complex, solutions within the current treaty framework, or to reach intergovernmental agreements outside it. The key test must not only be whether these solutions are politically achievable, but whether they are really needed and, if they are, whether they will be effective in tackling the weaknesses in EMU.

Inoculating the UK?

22. A key question for this report is where all this leaves the UK. The Government have made clear that, while they support measures to increase eurozone integration as necessary to stabilise the eurozone, they will not participate in any element of 'Genuine Economic and Monetary Union'. However they will seek to engage in negotiations as the proposed reforms are discussed in the European Council, in particular to ensure that the Single Market is not undermined by eurozone integration.[22] We agree that a strong and sustainable eurozone is in the best interests of the UK. However the Government need to consider whether their semi-detached position is sustainable in the long term, or whether, in the words of one of our witnesses, the UK will ultimately need to choose whether to be in or out.[23] We consider this issue in more detail in Chapter 4.

Bottling the cure

23. The economic and political context of 'Genuine Economic and Monetary Union' prompts the following questions:

· How far towards this model is it politically realistic to expect the eurozone to move?

· Will this be far enough to ensure that the foundations of Economic and Monetary Union are stabilised and strengthened?

· Will this be sufficient to reassure the markets about the single currency's continuing viability?

· Which elements of 'Genuine Economic and Monetary Union' are required to bring this about? Which aspects should be pursued as a matter of priority? Which can be put to one side?

· How long will it take to achieve the necessary reforms?

· Will treaty change be required, and if so, for which elements of 'Genuine Economic and Monetary Union'?

· What will be the impact of all of this on the Single Market in general, and the UK in particular?

These questions form the basis of our report.

24. The most effective cure to EMU's flaws, namely full fiscal and political union, is politically unachievable. Although a full and 'Genuine' Economic and Monetary Union as envisaged by the Commission may be beyond reach and would also entail more changes than are strictly necessary, a strengthened EMU is both vital and achievable.

This report

25. In line with the remit of the EU Economic and Financial Affairs Sub-Committee, which conducted this inquiry, this report focuses on the first three pillars of 'Genuine Economic and Monetary Union':

· An integrated financial framework;

· An integrated budgetary framework;

· An integrated economic policy framework.

Our analysis of the first pillar builds upon and takes forward our December 2012 report, European Banking Union: Key issues and challenges.[24]

26. The fourth pillar, democratic legitimacy and accountability, is vital, in particular in the current context of political uncertainty and instability in a number of Member States. This issue is directly relevant to the EU Committee's current inquiry into the role of national parliaments in the EU. We will consider such important questions fully in the report on that inquiry.

27. Our findings are based on oral and written evidence collected between May and November 2013 from a range of witnesses including Nicky Morgan MP, Economic Secretary to the Treasury, politicians, academics, economists and media commentators. We also undertook two visits during the course of this inquiry. Our visit to Brussels in October 2013 enabled us to meet with Commission Vice-President Olli Rehn, members of the European Parliament Economic and Monetary Affairs (ECON) Committee, and a number of Brussels-based thinktanks and experts. Our visit to Berlin and Frankfurt in November 2013 enabled us to understand the German perspective on 'Genuine Economic and Monetary Union' and on the UK's position. We met with a cross-party panel of German politicians, leading economists and, in private meetings, with the German Ministry of Finance, the German Bundesbank and the ECB. We also sought to gain a sense of the perspective of other Member States, and our witnesses included academics, politicians and government representatives from France, Portugal, Spain and Italy. We are grateful to all of our witnesses for their assistance. We are also grateful to Professor Iain Begg, Professorial Research Fellow, European Institute, London School of Economics, who acted as Specialist Adviser for this inquiry.

28. We make this report to the House for debate.

1 It should be noted that many elements of 'Genuine Economic and Monetary Union' were not new proposals, and had in fact been set out in the 1989 Delors Report on Economic and Monetary Union in the European Community. Back

2 Van Rompuy, H., President of the European Council (26 June 2012), 'Towards a Genuine Economic and Monetary Union'. Back

3 European Council Conclusions (29 June 2012). The report was prepared by President Van Rompuy in close collaboration with the Presidents of the European Commission, the Eurogroup and the European Central Bank, colloquially known as the 'Four Presidents'. Back

4 Van Rompuy, H., President of the European Council (5 December 2012), 'Towards a Genuine Economic and Monetary Union'. Back

5 European Commission (30 November 2012), 'A Blueprint for a Deep and Genuine Economic and Monetary Union: Launching a European Debate', COM (2012) 777 FINAL. Back

6 Ibid. Back

7 Ibid. Back

8 The Stability and Growth Pact was agreed in 1997 and entered into force in 1998 and 1999. Back

9 House of Lords European Union Committee, The future of economic governance in the EU (12th Report, Session 2010-12, HL Paper 124). Back

10 Mario Draghi, President of the European Central Bank, speaking to the European Parliament (16 December 2013). Back

11 de Larosière, J. (Chairman) (2009), 'The High-Level Group on Financial Supervision in the EU: Report', 25 February.