The European Union is going through a very difficult phase, besieged by epochal challenges in its internal and external security, hit by migratory flows that are difficult to control, seriously unpopular among its citizens. With Brexit we had for the first time the tangible sign that the processes of European integration are not irreversible. This is not, I think, this evening's theme, but it is certainly the background that our reasoning must keep in mind.
Eurozone: economic stability could prove ephemeral
I focus my preliminary observations on the eurozone economy. The first consideration is this. Financial conditions in the eurozone are currently fairly stable, but this could prove to be ephemeral stability, as underlying tensions and divergences remain in the euro system that could reignite instability.
On the one hand, the divergences in fundamental variables between the center and the southern periphery have widened. In this area, policies to contain deficits and public debts are encountering growing internal obstacles, in the presence of high unemployment and low growth. They stay extensive areas of weakness in banking systems. Political systems are undermined byemergence of populist parties who exploit popular discontent to fuel anti-European sentiments.
On the other hand, common economic policies are at a standstill. The credibility of the Stability Pact is weakened, caught in the pincers of the opposing visions of those who ask for respect for the rules and those who ask for flexibility to face imminent electoral deadlines. The banking union negotiation in the ECOFIN Council was frozen due to the lack of agreement on the issue of risk reduction. The Commission is criticized in Berlin because it fails to enforce the rules, in Rome because the rules are considered too strict.
And, I must add, the freedom of maneuver of the ECB appears reduced, both because the effectiveness of its expansive measures appear to be in doubt, and because the hostility of the financial world towards its purchases of securities and negative interest rates is growing. If Draghi were to bring forward the announcement of a gradual exit from quantitative easing policies to spring, this could be the expected signal from the markets to resume betting against the euro and make the risk of 're-denomination' for debts reappear of certain countries.
In this situation, new financial shocks cannot be ruled out and, if they occur, they risk not finding adequate answers to stabilize the markets due to the deep-seated disagreements between the economic policy authorities of the euro member countries – disagreements that would pave the way for destabilizing attacks on the markets more or less as happened in 2011-12.
Cooperation at risk of breakdown
The second consideration concerns precisely this point, i.e. the virtual rupture of cooperation in macro-economic policies and the abandonment of the design prefigured in the Report of the Five Presidents. That design envisaged a strengthening of the common instruments of discipline on national budgetary policies - with the establishment of a European finance minister, endowed with direct powers of intervention - together with elements of strengthening of the fiscal union and the introduction ofcommon bank deposit insurance. These two elements would have implied a certain sharing of macro-economic and financial risks, offering a shield to the euro against the danger of new financial shocks.
That drawing today in Berlin seems abandoned, or at least passed into the background. On the other hand, the hypothesis of strengthening discipline through market mechanisms is welcomed: that is, leaving economic policy and budgetary decisions at the national level, but providing that the country in financial difficulty that makes use of common support mechanisms - the European Stability Mechanism (ESM) – must first undergo an automatic 'restructuring' ('haircut') of its public debt, imposing losses on the holders of its bonds. The next step in the direction of greater stability of the euro system would therefore be this, the announcement to the markets that the sovereign debt of the most indebted countries could be subject to automatic losses.
I fully understand the argument that IN BALANCE a system including such a clause would automatically impose greater market discipline on more indebted countries. But at the same time I worry about the destabilizing effects that could not be missing in the transition phase from the current system to the new one.
I recall, in this regard, that the real trigger of the contagion in the eurozone sovereign debt crisis – from Greece to Portugal, Spain, Italy and even France – was the decision, announced in Deauville by the leaders of France and Germany, to impose substantial losses on private investors on Greek public debt in their portfolio. Investors took it, rightly so, as the announcement that the sovereign debts of euro countries could no longer be considered risk-free investments. I also recall that the following acute market instability was the lever used by Germany to impose austerity policies on its partners, which led to a new phase of severe recession – after that of 2009 – concentrated in the indebted periphery of the euro area.
So, it seems to me the signs of the will to apply that medicine again multiply, in a context in which even the ECB's relief interventions would be more difficult – given that this time the announcements – whatever it takes – would probably be ineffective and real money would be needed for interventions to support the sovereign bonds under attack. In fact we know that that money could not be spent without an agreement on stabilization policies within the ESM, an agreement which requires the unanimity of the member countries, therefore the consent of Germany.
Here, I wonder if this is the scenario towards which we are moving. I also wonder if there is full awareness that perhaps the euro would not survive a new changeover of this type.
The final set-up of the monetary union
My last consideration concerns an aspect of the design of the FINAL ARRANGEMENT of the monetary union – imagining that sooner or later a sufficient degree of economic convergence takes place, that public debts have been credibly brought under control, that the banking union has been completed with common deposit insurance and adequate fiscal back-up mechanisms in the event of a systemic cross-border banking crisis.
It seems to me inevitable that in this final arrangement the rule of bailout of sovereign debtors – no-bail-out – which has in fact been suspended in recent years. Indeed, the experience of federal states indicates that this is a fundamental condition of financial stability. However, I wonder whether the consequences of this requirement for a stable monetary union are fully recognized.
The history of federations shows that when the debts of sub-federal government units are no longer risk-free – which is a direct consequence of the application of the no-bail-out rule – there must also exist a risk-free security issued at the level of the federation.
This is necessary to provide the liquidity tool that underpins every financial system. For example, a fractional banking system (one in which banks keep only a fraction of the money they receive from depositors in reserve, and lend the rest to the economy) needs a perfectly liquid instrument, traded on a large market. , in which banks and investors can invest their liquidity.
The existence of a common debt instrument naturally brings with it a common fiscal capacity, with various methods of intervention. For example, it could be used for liquidity interventions by the ECB or provide the Treasury of the federation with resources for anti-cyclical interventions, or still be used to contribute to the financing of projects for European infrastructures for the internal market - projects which naturally guarantee a yield higher than the cost of the issue on the market. The management of emissions could be entrusted to the ESM, which already potentially constitutes the core of a common fiscal capacity.
The existence of a common debt instrument and fiscal capacity naturally presupposes a federation finance minister, with adequate powers to manage common policies under the control of the ESM Council (in effect, the finance ministers of the Euro Group). We would return to the pattern prefigured in the Report of the Five Presidents.
