How Juncker set the stage: the future of Monetary Union

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With a number of “I have a dream” proposals, focusing on issues ranging from social rights to the EU decision-making processes, Jean-Claude Juncker’s State of the Union speech - on September 13 - envisioned a stronger, more united and democratic EU, able to dare more and become a truly global actor. Yet, when it came to the European Monetary Union, Junker’s proposals to create a European minister of financial affairs and to transform the European Stability Mechanism (ESM) into a European Monetary Fund (EMF) appeared only sketched and unambitious.

Juncker only mentions, in passing, the set-up of a European Monetary Fund. We believe that the Fund should have a larger lending capacity than the ESM, which currently stands at about €370 billion against a total government debt amounting to around €10 and €13 trillion respectively in the euro area and in the EU. While the ESM is indeed adequate as a first line of defense for small or mid-size countries, it would barely cover one year of refinancing needs for a large country. To be effective and reassure the market about the EU’s capability to isolate sovereign crises, the European Monetary Fund should be backed by an augmented capital endowment transferred by Member States. In addition, its decision-making process should be streamlined by downsizing the veto power of national ministers. Also, the EMF should finance its interventions by borrowing money and issuing bonds in exchange. This could be the prelude for a debt mutualisation scheme, with national sovereign debt being gradually substituted by the EMF bonds, thus creating in the medium term a liquid and thick market of safe European bonds. Such assets would serve as a store of value and as a pricing benchmark. They could help resolve the long querelle on how to limit banks’ exposure to public debt, and could contribute to breaking the vicious feedback loop between banks and sovereigns.[1]

According to Juncker, the minister of financial affairs would be empowered to rapidly respond to short-term contingencies, by supervising the use of financial assistance instruments for Member States. In this respect, we believe that the effectiveness of action would crucially depend on the institutional design: the minister should have power to autonomously decide the destination of resources and to rapidly mobilize them. For this to be possible, the governance of the ESM/EMF should be effectively revised, as discussed above.

Juncker also proposes that the minister should coordinate the structural reforms necessary to enhance growth potential in the long run. This provision could in principle increase efficiency if, when suggesting optimal national policies to Member States, he or she internalizes the possible spillovers of national policies (e.g. in terms of labor market legislation or fiscal affairs) or, even better, if the minister designs optimal European economic policies relying on increased EU own resources. In this way the minister would compose the often divergent national interests into what is best suited for the Union as a whole.  In the same vein, we suggest that the Minister coordinates the European Investment Plan.

On the whole, these arrangements would mark a truly difference with respect to the status quo only if the Minister is endowed with the power to effectively enforce his decisions vis-à-vis the Member States, which calls into question the democratic legitimacy of the European institutions and the opportunity of a (partial) transfer to the center of national sovereignty.

While calling for the creation of a single economic Minister and of a Monetary Fund, Junker stepped back from the idea of a euro area budget/fiscal capacity, which was instead envisaged in previous reports and which is, in our opinion, fundamental to overcome future crises and to increase efficiency in designing and implementing effective growth-friendly economic policies for the area (as discussed above for the EU). In fact, in the US and other federations around 80% of income shocks to sub-national components are smoothed, either via capital markets (by around 50-70%) or through public transfers; by contrast, income shocks to Eurozone countries are only about 40% smoothed, with fiscal risk sharing found to be nearly zero.[2] In addition, factors such as cross-country labor mobility and financial markets integration, which normally help equalize conditions across countries, are below the level registered in the US.[3] Although cyclical convergence is improving, “a strong Euro area budget line” is hardly compatible with the constraint of the EU budget equaling 1% of the bloc’s GDP. A central fiscal stabilization function is paramount in the euro area, as the unique monetary policy cannot react to the economic conditions of individual countries, while they cannot rely on the lever of the exchange rate to cushion shocks.

To date, positive economic trends registered in the EU, both in terms of output and employment (among others), show that recovery is back on track and create favorable conditions to reform and reinforce the EU. Hence, what prevented Junker from daring more is probably related to national egoisms and political deadlocks. National governments are still battling, putting short-term national interests before the common good and, in some cases, spreading the ideas that some countries are growing at the expenses of others. These arguments cause national governments to be  reluctant in embracing “more risk sharing” and might even fuel nationalistic sentiments, all in a moment when many European countries are expecting national elections or even a referendum for independence.

Indeed, Juncker could have been bolder and could have provided further substance to his proposals. Nevertheless, given the current conditions, his speech would probably have remained an enthusiastic appeal, not enough to avert a mere “carrying on” tendency. Now that the storm has passed and Europe is at a crossroads; there is Brexit and differentiated integration is on everyone's lips. Beyond Juncker’s words it might be time for member countries to dare and integrate more, concentrating their efforts on deepening the EU, taking advantage of the signs of economic recovery and increased resilience, instead of cherry picking from the common project.

[1] The technical details of the implementation of this scheme and the possible effect on the national public debt of a gradual switch of market demand away from it and towards EMF bonds are another issue, and require further analysis.

[2] Balassone F., Cecchetti S., Cecioni M., Cioffi M., Cornacchia W., Corneli F., Semeraro G, Risk Reduction and Risk Sharing in the Governance of the Euro Area, Journal of Economic Policy, 2016 (3), pp. 463-488.

[3] Of course, increasing risk sharing through fiscal instruments is not enough by itself. Reforms helping integrating capital and labor markets are equally needed. We put an emphasis on fiscal policies because this is the field where national governments have more direct control.

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