euro-area governance: what to reform and how to do it

EURO-AREAGOVERNANCE: WHATTO REFORM AND HOWTO DO IT

bruegelpolicybriefISSUE 2015/01FEBRUARY 2015

by André SapirSenior Fellow at Bruegel

[email protected]

and Guntram B. WolffDirector of Bruegel

[email protected]

POLICY CHALLENGE

Euro-area governance needs to move beyond the improvements broughtabout by banking union and should establish institutions to prevent diver-gences of wages from productivity. We propose the creation of a EuropeanCompetitiveness Council composed of national competitiveness councils,and the creation of a Eurosystem of Fiscal Policy (EFP) with two goals: fis-cal debt sustainability and an adequate area-wide fiscal position. The EFPshould have the right in exceptional circumstances to declare nationaldeficits unlawful and to be able to force parliaments to borrow more so that

the euro-area fiscal stance is appro-priate. A euro-area chamber of theEuropean Parliament would have toapprove such decisions. No addi-tional risk-sharing would beintroduced. In the short term, domes-tic demand needs to be increased insurplus countries, while in deficitcountries, structural reform needs toreduce past divergences.

Real effective exchange rates, relative tothe rest of the euro area, % change

THE ISSUE Reform of the governance of the euro area is being held back bydisagreement on what is at the root of the euro area’s woes. Pre-crisis, theeuro area suffered from the built-up of financial imbalances, price and wagedivergence and an insufficient focus on debt sustainability. During the crisis,the main problems were slow resolution of banking problems, an inadequatefiscal policy stance in 2011-13 for the area as a whole, insufficient domesticdemand in surplus countries and slow progress with structural reforms toovercome past divergences.

Source: Bruegel. Selected euro-area countries.

-20

-15

-10

-5

0

5

10

15

20

Germany France Netherlands Italy Spain

1999 Q1 to 2008 Q4

2009 Q1 to 2014 Q3

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EURO-AREA GOVERNANCE: WHAT TO REFORM AND HOW TO DO IT

1. See, for example,Carney (2015). Recent

ECB measures arewelcome but may proveinsufficient to prevent a

lost decade.

2. See Sapir (2005).General policy

complacency and thegreat moderation werefurther factors leading

to the build-up ofimbalances.

3. In particular, thebank resolution frame-

work, the depositinsurance system andcapital markets union

are important elementsfor further work.

JUST AS IT WAS CELEBRATING itstenth anniversary, the euro areawas hit by a financial crisis thatstarted in the United States butrapidly spread to Europe. Eco-nomic and Monetary Union (EMU)was ill prepared to deal with theimmediate crisis and the large fis-cal, financial and structuralimbalances that had accumu-lated over the years. The financialcrisis turned first, in 2010, into aGreek sovereign crisis and then,in 2011-12, into a full-blownbank-sovereign debt crisis that atone point threatened the veryexistence of the monetary union.The debt crisis has now abatedbut an economic crisis, with fee-ble growth and near-zero inflation,has replaced it. A lost decadebeckons for the euro area, but itsgovernments have been slow torespond1.

The euro area has two featuresthat have been particularlyresponsible for the crisis and forthe difficulty of resolving it: majoreconomic (and also political andsocial) differences between coun-tries2 resulting in some cases infailed policies, and the euro area’sinadequate economic gover-nance. Reform of this governanceis needed in three major areas.

First, although fairly integrated,especially within the euro area,Europe’s banking and financesystem was left to operate with-out corresponding supervisoryand resolution structures. Bank-ing Union and variousmacro-prudential measures con-stitute a proper institutionalresponse, though they will needto be improved in due course – asubject that is beyond the scopeof this Policy Brief3. Second, in the

absence of a nominal exchangerate and without a fully integratedlabour market, the euro areaneeds a system to prevent largedivergences between the unitlabour cost (ULC) developmentsin its member countries. Third, theeuro area needs a fiscal gover-nance system to (1) ensure thefiscal sustainability of individualmembers, (2) to generate anappropriate area-wide fiscalstance, and (3) to quickly providefiscal resources forprompt resolution inthe event of bankingand sovereign crises.We propose medium-term governancereforms to addressthe second and thirdof these issues,before concludingwith the most pressing short-termchallenges.

THE RUN UP TO THE CRISIS:EMU’S SHORTCOMINGS

From the outset, the euro areacomprised two groups of coun-tries with substantially differentsocio-economic models and con-sequently different macro-economic policies and outcomes:the core countries that belongedto (or shadowed) the ExchangeRate Mechanism (ERM) for morethan a decade prior to the launchof the euro, and the peripheralcountries that stayed mostly out-side the ERM.

Different initial conditions in thecore and the periphery, mainly interms of interest rates, led to thecredit boom in the peripheryfinanced by capital flows from thecore. This led to increasing com-petitiveness problems within the

euro area, which were insuffi-ciently monitored and difficult tocounter in the absence of theexchange rate instrument. As aresult, current-account balancesand net foreign asset positionsdiverged to an unprecedenteddegree between the core (in sur-plus) and the periphery (indeficit). When the financial crisishit in 2008-09, private capitalflows from the core to the periph-ery suddenly stopped (Merler and

Pisani-Ferry, 2012),leaving behind amountain of external(private and public)debt in the peripheryowed to creditors inthe core countries.Italian and Frenchprice competitive-ness diverged

relative to Germany, but neithercountry ran significant currentaccount deficits.

Instead of producing sustainablereal convergence between thecore and the periphery, the singlecurrency had resulted in imbal-ances and was ill-prepared to dealwith them. Insufficient attentionwas paid to the build-up of finan-cial imbalances. This failure wasnot specific to the euro area, butthe European monetary unionwas unique in that it lacked com-mon supervision and resolutionmechanisms to properly addressfinancial crises within the inte-grated financial system.

This shortcoming, along withdeeply entrenched opposition tobank resolution in a system char-acterised by major inter-dependencies between politicalsystems and banks (Monnet et al,2014), was a major hindrance in

‘The singlecurrency resulted inimbalances andwas ill-prepared todeal with them.’


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4. The so-called six-pack, two-pack, Euro+

pact and the FiscalCompact. See

http://ec.europa.eu/economy_finance/articles/g

overnance/2012-03-14_six_pack_en.htm.

5. From 7.5 percent in2007 to 12 percent in2013 (11.6 percent in

2014).

6. Stressed countriesincluding Cyprus,

Greece, Ireland, Portu-gal and Spain reduced

their current-accountdeficits on average byaround 10 percentagepoints between 2007

and 2014.

getting to grips with a Europeanfinancial-cum-sovereign-debt cri-sis of considerable magnitude,which evolved in 2011-12 fromthe global financial crisis.

Another weakness of the euroarea's economic governancearchitecture was that it lacked amechanism to monitor and cor-rect macroeconomic imbalances,except in budgetary policy.Enforcement of the deficit ruleswas inadequate, public debt sus-tainability received relatively littleattention and private debt noattention at all. Similarly, externaldebt (and current account imbal-ances) was all but ignored.Moreover, no attention was paidto long-term and persistent ULCdivergences.

The lack of focus on public debtsustainability led to two types ofsituations: (1) Fiscal rules wereinsufficiently applied, partlybecause there was inadequateunderstanding of the debt sus-tainability risks. Stricterapplication of the rules wouldhave reduced future debt prob-lems in Italy (and other countries)and in Greece, where enough wasknown to justify more forcefuldemands for corrective action. (2)Countries like Ireland and Spainthat, although they abided by thefiscal rules, proved not to beimmune to debt problems oncethe financial crisis erupted,revealing the huge build-up of pri-vate debt that led to problems fortheir public finances.

Governance mechanisms toaddress macroeconomic imbal-ances such as wage divergencesdo not exist in true federationssuch as the United States. The

euro area needs mechanisms toaddress both competitivenessdivergence and coordination offiscal policy, because labourmobility is limited and fiscal pol-icy decentralised.

CRISIS MANAGEMENT: WHATWORKED AND WHAT DID NOT?

When the global crisis triggeredthe European crisis, the Europeanpolicy system was largely unpre-pared. Crisis management during2008-14 consisted of:

• A timely coordinated macro-economic response in 2009consisting of monetary-policyeasing, the European CentralBank playing the role of unlim-ited lender of last resort tobanks and a substantialincrease in fiscal deficits.

• Hesitant and delayed crisismanagement, with countrieslosing market access com-bined with the gradualestablishment and reinforce-ment of institutions that canprovide financial assistanceand impose conditions for pro-viding that assistance.

• A gradual process starting withthe ‘Van Rompuy task force’(European Council, 2010) tostrengthen EU surveillancemechanisms, resulting in newrules and mechanisms4.

• When the sovereign debt crisisbecame more widespread andyields increased substantiallyin Italy and Spain, quicker fis-cal consolidation and ECBsupport was implementedthrough the Securities MarketsProgramme (SMP) and OutrightMonetary Transactions (OMT)programme.

• As banking and sovereign

stresses reinforced each otherand bank resolution wasdelayed, the European Councildecided to establish a bankingunion to de-link banks fromtheir sovereigns and increas-ing financial stability. Thebanking union project is nowofficially finished.

The crisis response has not deliv-ered economic results for theeuro area. GDP has not grownsince 2008, and unemploymenthas increased5. Inflation hasfallen substantially and inDecember 2014, area-wide defla-tion (of -0.2 percent) wasrecorded for the first time since2009. Internal adjustment hasproceeded, with current-accountdeficits shrinking substantially6.However, current account sur-pluses have, if anything,increased in Germany and theNetherlands, reaching 7 percentof GDP or more in 2014. There wassome wage and price adjustmentin the crisis countries, but relativeprices between the three biggesteuro-area countries – Germany,France and Italy – have adjustedonly marginally. The very lowarea-wide inflation rate has nothelped: the lower it falls, the moredifficult it becomes to achieve thenecessary adjustment.

The euro area has not delivered.What went wrong in the last sevenyears, contributing to such a badeconomic performance? Besidesthe severe macroeconomic imbal-ances at the beginning of thecrisis, the following problems canbe identified:

• From 2011 to 2013, fiscal pol-icy in the euro area waspro-cyclical. In 2014, fiscal

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policy was flat and did notcounteract the continuingdeterioration of the economy.Public investment and R&Dexpenditure have been cutduring the crisis.

• Europe has taken a gradualapproach to bank resolution;unresolved banking issuescontinue to plague credit provi-sioning in the euro area(European Systemic RiskBoard, 2012). Banking prob-lems were not addressedbecause of national politicalconstraints and because ofpossible fiscal consequences.

• The ECB has been slow torespond to the deterioratingeconomic situation and hastried to avoid taking risk onboard. It also misjudged thesituation twice, resulting inerroneous rate increases.

• No serious and significantmeasures to address pricedivergence between Germany,France and Italy have beenundertaken. Structural reformsprogressed in all three coun-tries largely in line withnational political constraints,but were not commensuratewith the need for adjustment ina monetary union where, bydefinition, adjustment cannottake place through exchangerate changes. Moreover, noeuro-area wide demand man-agement was undertaken tofacilitate relative adjustment.

This analysis highlights the twocentral problems for euro-areagovernance:

a) Fiscal policy: no institution isresponsible for the area-widefiscal stance and for the distri-bution of fiscal policy across

countries, and no fiscalresource (except the EuropeanStability Mechanism) is avail-able for risk sharing, includingin banking.

b) Only a very weak mechanism(the Macroeconomic Imbal-ances Procedure) exists toensure that wage develop-ments are in line withproductivity, which meansthat serious competitivenessproblems can anddo occur within theeuro area. Wagesetting remainsmainly a nationalprocess with littleor no regard foreuro-area develop-ments. Othernational structuralpolicies are implemented with-out consideration ofpotentially substantial cross-border effects.

Beyond these two governanceproblems, some euro-area coun-tries suffer from very significantdebt burdens and differences insocial and employment perform-ances and in the structuralfeatures of their economies.These legacy problems make gov-ernance reform significantly morecomplicated.

ON WHAT GOVERNANCE REFORMSSHOULD THE EU FOCUS?

The issue of sovereignty, or politi-cal legitimacy over policies, liesbehind both governance prob-lems we have highlighted.

Wages and competitiveness

In many countries, persistent ULCincreases were driven by unsus-

tainable asset price booms result-ing in overheating labour markets.The answer to such problems liesin better macro- and micro-pru-dential policies and betterregulation of the financial system,which are beyond the scope ofthis Policy Brief.

Yet trying to prevent asset boomsis not sufficient to address allcompetitiveness problems in the

euro area, wherecountries often havelabour markets andsocial systems thatare incompatible withtheir membership of amonetary union.Other reforms thatincrease economicdynamism – for

example the creation of a singleand competitive market or thereduction of harmful regulation –are also essential.

The functioning of national labourmarkets must not lead to exces-sive competitiveness divergence.National wage formation and bar-gaining systems vary widely. As aresult, the alignment of nominalwage growth with labour produc-tivity growth at national level alsotends to differ considerably in dif-ferent countries. Such differenceslead to inter-country changes incompetitiveness, which are diffi-cult to correct within the euro areabecause of the absence of theexchange rate instrument.

There are two basic solutions tothis problem. The first would be tocreate a system comparable to atrue federation with a singlelabour market. In the UnitedStates, citizens accept the model,in which they move regularly in

‘Preventing assetbooms will notaddress allcompetitivenessproblems in theeuro area.’

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EU legislation and their perform-ance monitored by the EuropeanCommission.

All euro-area countries should putin place a competitiveness-moni-toring framework involvingregular assessments and the def-inition of instruments to preventproblems. An interesting exampleis the Belgian framework, intro-duced in 1996 to preserve thecountry’s competitiveness in EMUby keeping the evolution of wagesin line with wage developments inthe main trading partners. Anational body regularly reports onthe evolution of Belgian competi-tiveness relative to its three maintrading partners (Germany,France and the Netherlands).These reports are used by socialpartners to fix a wage norm for thenext round of wage negotiations.Although the norm amounts onlyto a non-binding guideline, it hasgenerally been respected by theprivate sector (to which the sys-tem applies). In case socialpartners fail to agree a wage normcompatible with theevolution of competi-tiveness, thegovernment can stepin and make the normlegally binding. Thesystem has workedfairly well: it keptuntouched the wageformation and bar-gaining system that existed priorto the euro, but made the behav-iour of social partners compatiblewith membership of the euro area.The result has been that ULCs inBelgium have evolved more-or-less in line with those in its maintrading partners, thus avoidingmajor competitiveness problems.

The Belgian system could beimproved, and anyway cannot beexactly copied by other euro-areacountries since they typically havedifferent wage formation and bar-gaining systems. What is importantis that all euro-area countries put inplace a mechanism to ensure that,although operating within theirown system, the behaviour ofsocial partners and the outcome oftheir wage negotiations is compati-ble with membership of the euroarea in terms of competitivenessand employment. These nationalmechanisms would constitutenational competitiveness councils.

We would recommend thereforethe creation of a EurosystemCompetitiveness Council (ECC)consisting of both national com-petitiveness councils and theEuropean Commission. The ECC’sprimary task would be to coordi-nate the actions of nationalcompetitiveness councils toensure that no euro-area countryfixes a wage norm that impliessignificant competitiveness prob-

lems for itself and/orothers. In case thisfails, the Commissionshould have thepower to require therelevant competitive-ness councils to takecorrective actionusing the MIP and theEuropean Semester

instruments.

Fiscal policy

The euro area faces the choice ofeither significantly moving aheadwith fiscal integration whileaccepting that national parlia-ments lose some power (egMarzinotto et al, 2011), or imple-

their lifetime from one state toanother. The cost of such movesis limited because of the unifiedmarket and the absence of lan-guage barriers and barriers in thewelfare system.

The alternative model starts fromthe assumption that it is neitherdesirable nor feasible to create aunified European labour market inwhich a unified welfare systemwould enable citizens to changetheir country of residence severaltimes in their lifetimes. Someincreased mobility is probablydesirable and feasible, but wealso strongly believe that the euroarea will not for the foreseeablefuture create such a unifiedlabour market in which regionalshocks can be essentially fixedby large migration flows.

The euro area, therefore, needsmechanisms to prevent and cor-rect substantial misalignments ofcompetitiveness between itsmember countries. Since wageformation and bargaining sys-tems are deeply rooted anddifficult to change, deviations incompetitiveness must be moni-tored and corrected before theybecome too significant andentrenched.

At EU-level, the MacroeconomicImbalance Procedure (MIP) hasthe potential to be an importanttool and should be applied sym-metrically to correct excessivepositive and negative imbal-ances. The MIP needs however tobe complemented by nationalprocedures to monitor and, ifneeded, correct competitivenessproblems and to increase owner-ship at the national level. Theseprocedures should be required by

‘All euro-areacountries shouldput in place acompetitiveness-monitoringframework’

menting a fully decentralisedsolution in which fiscal decisionsare taken completely at thenational level (eg Mody, 2013).For the latter, it is essential tohave a credible no-bail-out regimeso that national decisions haveprimarily national consequences.

The fully decentralised solution –accepting defaults without mech-anisms to safeguard financialstability – would be politically,socially and financially unstable7.More worryingly, a decentralisedsolution would not provide ade-quate euro-area widestabilisation, thereby forcingmonetary policy to do more thanit can achieve8.

The euro area therefore needs tohave a fiscal mechanism toreduce the pernicious effects ofrecessions, increase financialstability, reduce cross-bordercontagion and manage the falloutfrom debt restructuring should itbecome necessary, while govern-ment default should remain alast-resort option. There should be(a) the ability to steer a euro-areawide fiscal stance, (b)a fiscal capacity tomanage sovereigndebt and bankingcrises, and (c) a dif-ferent regulatoryframework for sover-eign debt9. Since thisamounts to a limitedinsurance system,mechanisms wouldhave to be in place to manage therisk of moral hazard.

The current system of fiscal rulesaims to establish smart, rules-based fiscal governance.However it fails in its aim because

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7. Technocratic solu-tions such as indexing

bonds to GDP areunlikely to be practical

and would require atotally different regula-tory framework. At theminimum, a European

sovereign debt restruc-turing mechanism

would be required; seeGianviti et al (2010).

8. See, for exampleCoeuré (2015) for a

recent discussion ofthe argument originally

made by Lamfalussy. Insituations like the cur-

rent one, monetarypolicy alone is insuffi-

cient to provideadequate stabilisation.

9. In Sapir and Wolff(2013), we argue for

the introduction ofexposure limits or riskweights on sovereign

debt.

10. It establishes anumber of criteria that

try to take account ofthe business cycle situ-

ation as well as debtsustainability in a

rules-based framework.However, the rules fail

to achieve what theypromise because of thetechnical impossibility

of computing outputgaps, as has been

amply documented.The discretion that isapplied as a result is

awkward and based on


of faulty rules and ill-definednational fiscal discretionaryspace10. There is a need to adjustthe current EU fiscal governanceframework through several inter-connected steps:

a) A reform of the fiscal frame-work addressing moralhazard. This could involve fis-cal federalism by exception11,with the focus of fiscal surveil-lance on debt sustainability.The closer a country moves tounsustainability, the strongerthe intervention would be, withultimately the completeremoval of the ability to bor-row. This enhancedgovernance would come on topof the ultimate possibility ofdebt restructuring.

b) The fiscal framework shouldnot only be given debt sus-tainability goals. It shouldalso ensure that the sum ofdeficits in the euro areaachieves a reasonable area-wide fiscal stance12. The newframework would thus not onlyhave the right to prohibit bor-rowing, overruling national

parliaments, but itwould also have theright to force memberstates to run higherdeficits, overrulingnational parliamentdecisions in substantialeuro-area recessions.In other words, thenotion of ‘fiscal feder-alism by exception’

should be symmetric. It shouldapply to countries with bothdangerously excessive deficitsand insufficient borrowing froma euro-area perspective.

c) The governance of fiscal sur-veillance could be organised

in a Eurosystem of Fiscal Pol-icy (EFP), composed of aGoverning Council (GC) thatwould be comparable to theEurosystem of central banks.At its centre would be a euro-area finance minister13. Thisperson would prepare themeetings of the GC togetherwith five budget directors thathave joint responsibility overthe ESM. All euro-area financeministers would also sit on theGC. The GC would take fiscalpolicy decisions based onqualified majority with the sixcentral representatives havinga substantial vote. These deci-sions would become binding atthe national level in case ofsubstantial danger to debt sus-tainability or a substantialeuro-area recession. In normaltimes, the size of fiscal deficitswould still be managed by thenational level and the recom-mendations of the EFP wouldnot be fully binding.

d) The EFP would also have thepower to activate fiscalresources of a fund, such asthe ESM, for special purposes.This would include providingsupport to individual memberstates in the context of an ESMprogramme, and backing-upbanks in cases of severe sys-temic stress14.

e) Such a system would raisesubstantial questions about itslegitimacy and the role ofnational parliaments and theEuropean Parliament. The ESMcurrently requires unanimityamong the finance ministers,and prior parliamentaryapproval in several countries.This has proven to be complex.At the same time, unanimity isjustified because the

‘The ECB wouldbe overburdenedif it had tomanage alone theeuro areabusiness cycle.’

resources needed to back upthe fund are national taxpay-ers’ resources. This system isultimately unsustainablebecause it regularly putsnational parliaments and deci-sion makers in a position ofhaving to vote on matters thatcould benefit banks elsewhereor even other countries.

f) We would therefore imagine asystem, in which political legit-imacy would beallocated to theEuropean leveltogether with Euro-pean tax-raisingpower. The Euro-pean or euro-areaparliament wouldbe allowed to raisea certain amount oftaxes to fund thecommitments of the commonfund in case the fund needs toborrow for extraordinary cir-cumstances. In other words,the European fund would drawon European resources requir-ing European legitimacy. A‘euro-area parliament’ wouldthus provide legitimacy todecisions on the ESM fund andwould also approve decisionsby the EFP-GC when they arebecome binding on nationalparliaments15.

g) This system would be a hugechange from the current sys-tem, in which legitimacy offiscal policy – despite a treaty-based framework ofcoordination – derives fromnational processes. In theEurosystem of Fiscal Policy,the majority decision would bebinding on national parlia-ments in the sense that incertain circumstances, theirability to borrow would be

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complicated political andtechnocratic compro-

mises.

11. As proposed byJean-Claude Trichet

(2011).

12. To achieve this, thereneeds to be first and

foremost an agreementthat this is actually a

desirable policy goal. Webelieve that our analysis

and the declining infla-tion rates clearly

demonstrate the weakfiscal dominance and

the substantial macro-economic problem that

the euro area has.

13. A European budgetcommissioner who can

reject national budgets ifthey fail to respect the

rules, as WolfgangSchäuble put it in a

speech in Bruges inMarch 2014 (Schäuble,

2014).

14. We thus envisage afurther development of

the ESM into a system inwhich decisions are

taken based on majorityvoting in the EFP insteadof unanimity of the ESMfinance ministers, as is

currently the case.

15. This was recentlyadvocated by Germanfinance minister Wolf-

gang Schäuble; seefootnote 13.

16. The EU Court of Jus-tice's 2012 Pringle


removed or they would beforced to borrow. Such a sys-tem would only be credible ifthe European Treaty and cer-tain national constitutionswere to change. It is also possi-ble to conceive such a systemwithout change to the Euro-pean Treaty and instead withthe establishment of a newintergovernmental treaty16.

h) To increase the new institu-tion’s objectivity, wealso recommend thecreation of an inde-pendent euro-areafiscal council thatissues opinions onthe decisions takenand in particular con-firms whether thereare exceptional cir-cumstances.

It is important to note that we donot propose the creation of a ‘fed-eral budget’. As essentially allgovernment spending wouldremain at the national level, thecreation of a federal capacitywould imply either shifting sub-stantial fiscal expenditures to thefederal level or increasing overallgovernment spending by creatingnew federal spending categories.The former option is unfeasible atthis stage while the latter is prob-ably undesirable given thealready large size of the govern-ment sector in many euro-areacountries.

It is also important to note that ourproposal does not foresee risksharing beyond the current ESMcapacities. Our system is essen-tially a stepped-up framework forfiscal policy coordination. A muchmore far-reaching step would beto establish a fiscal mechanism

for proper risk sharing betweencountries, such as a Europeanunemployment insurance mech-anism to complement nationalsystems. This would introducereal risk-sharing. However, thiswould arguably only be possible iflabour market conditions are har-monised significantly so that themechanism only insures againsttruly exogenous events ratherthan policy-induced ones (Claeyset al, 2014). More risk sharing isdesirable because debt levels arehigh in many countries andnational-level borrowing mightbecome constrained and financialmarkets might not be able to pro-vide adequate funding forstabilisation. But these differ-ences in starting positions willmake it very difficult to moveahead with a risk sharing option.

An important question is whetherthe treaty changes that would berequired to underpin theseproposed fiscal mechanisms, andthe additional sovereigntypooling that would go with them,would still be necessary for theeuro area’s functioning ifcompetitiveness and debt-overhang problems had beentackled. Our view is that theywould. A well-functioningmonetary union requires fiscalmechanisms to ensure thatshocks are met by the union as awhole. Problem solving in amonetary union cannot only beabout putting one’s house inorder; it must also be aboutputting the common house inorder. But this necessary changeof philosophy compared to thecurrent (Maastricht-based)approach will require a treatychange that can only beenvisaged once trust between the

‘We propose asymmetric fiscalfederalism byexception withappropriatelegitimacy.’

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countries and citizens of themonetary union has beenregained by implementingmeasures that require no treatychange but can go a long waytowards solving the currentsituation.

TRANSITION TOWARDS THE NEWGOVERNANCE SYSTEM

There is a pressing need toaddress two central problems inthe euro area immediately. First, itis imperative to increase inflationand demand. Second, it is impera-tive to address the substantial

macroeconomic policies andmessy debt restructuring wherenecessary.

In the next few years, it will bechallenging to manage acuteproblems such as high debt, highunemployment and weak growth.Leaders should keep in mind asense of direction towards a newgovernance model that cannot beachieved overnight. Yet, without aprocess starting now that willeventually lead to the necessarytreaty changes, the daily man-agement of the various crisesmay become impossible.

judgement (Case C-370/12) opened the

way for the creation ofadditional treaties with-

out changes to the EUtreaty.

divergences in ULC, in particularbetween France, Germany andItaly. This requires political con-sensus between governmentsbecause the ECB cannot continueto act alone to achieve theseobjectives. A reformed EuropeanSemester with better timing and agreater focus on euro-area recom-mendations could lead to achange in philosophy.

Correction of imbalances in bothsurplus and deficit countries isessential as is dealing with thestock of debt through a combina-tion of more aggressive

REFERENCES

Carney, Mark (2015) ‘Fortune Favours the Bold’, lecture to honour the memory of The Honourable James MichaelFlaherty, Iveagh House, Dublin, 28 January

Claeys, Grégory, Zsolt Darvas and Guntram Wolff (2014) ‘Benefits and Drawbacks of European UnemploymentInsurance’, Policy Brief 2014/06, Bruegel

Coeuré, Benoît (2015) ‘Lamfalussy was right: independence and interdependence in a monetary union’, speech atLamfalussy Lecture Conference, Budapest, organised by Magyar Nemzeti Bank, 2 February

European Council (2010) Strengthening Economic Governance in the EU, Report of the Taskforce to the EuropeanCouncil

European Systemic Risk Board (2012) ‘Forbearance, resolution and deposit insurance’, Reports of the Advisory Sci-entific Committee No. 1/July

Gianviti, Francois, Anne O. Krueger, Jean Pisani-Ferry, André Sapir and Jürgen von Hagen (2010) A European mech-anism for sovereign debt crisis resolution: a proposal, Blueprint 10, Bruegel

Marzinotto, Benedicta, André Sapir and Guntram Wolff (2011) ‘What kind of fiscal union?’, Policy Brief 2011/06, BruegelMerler, Silvia and Jean Pisani-Ferry (2012) ‘Sudden stops in the euro area’, Policy Contribution 2012/06, BruegelMody, Ashoka (2013) A Schuman compact for the euro area, Essay and Lecture Series, BruegelMonnet, Éric, Stefano Pagliari and Shahin Vallée (2014) ‘Europe between financial repression and regulatory cap-

ture’, Working Paper 2014/08, BruegelPisani-Ferry, Jean, André Sapir and Guntram Wolff (2011) An evaluation of IMF surveillance of the euro area, Blue-

print 14, BruegelSapir, André (2005) ‘Globalisation and the reform of European social models’, Policy Contribution, BruegelSapir, André and Guntram Wolff (2013) ‘The neglected side of banking union: reshaping Europe’s financial system’,

note presented at the informal ECOFIN, 14 September, VilniusSchäuble, Wolfgang (2014) ‘Strategy for European recovery’, speech at the Fifth Bruges European Business Confer-

ence, 27 MarchTrichet, Jean-Claude (2011) ‘Building Europe, building institutions’, speech on receiving the Karlspreis 2011 in

Aachen, 2 June

© Bruegel 2015. All rights reserved. Short sections, not to exceed two paragraphs, may be quoted in theoriginal language without explicit permission provided that the source is acknowledged. Opinions expressed inthis publication are those of the author(s) alone.

Bruegel, Rue de la Charité 33, B-1210 Brussels, (+32) 2 227 4210 [email protected] www.bruegel.org

euro-area governance: what to reform and how to do it

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