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12 October 2011

Jürgen Stark: Economic adjustment in a monetary union


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Mr Stark said that for both Latvia and euro area countries, the challenge is to implement an economic adjustment without using the nominal exchange rate as an instrument. In Latvia, the authorities chose not to use that option, whereas in the euro area that option is no longer available.


Some euro area countries are facing similar challenges to those facing Latvia during the past three years. Although the magnitudes and some other features may differ, the broad characteristics are the same. In both cases, there is a need for adjustment as a result of macro-economic imbalances, losses in competitiveness and unsustainable economic policies.

Lessons from the crisis

Macro-economic imbalances and unsustainable fiscal policies are the root cause of the sovereign debt crisis in the euro area. The existing economic governance framework has not been able to prevent the emergence of excessive macro-economic imbalances. Moreover, fiscal policy coordination in the euro area turned out to be completely insufficient. An institutional framework focusing on the early identification and correction of macro-economic imbalances would have helped to prevent these problems. But the ongoing crisis is also a symptom of policy failures and deficiencies in the existing institutional framework governing economic policies in EMU. The Broad Economic Policy Guidelines, the central link in coordination of the Member States’ economic policies, did not work. The instruments and procedures were available. But they were either not implemented or ignored, or they were watered down. Peer pressure among the Member States – potentially a strong tool of mutual fiscal surveillance – fell short of what was needed as countries did not attach sufficient importance to their joint responsibility for the stability of the euro area.

Several proposals have been made on how to overcome the flaws in the EMU governance framework. Addressing EMU’s difficulties requires a major strengthening of the rules and organisations that govern fiscal and other economic policies. The identification of the necessary reforms has to begin with the ultimate objective: institutional arrangements that provide credible incentives for sound policies.

Euro area countries and countries preparing for euro adoption should be aware that this requires the transfer of sovereignty to a central institution with much stronger powers. It also requires stricter rules on the preparation and implementation of budgets at the national level.

The recent agreement reached by the European Parliament and the Council on the economic governance package is a step in the right direction. But it falls short of the “quantum leap” in economic governance that the ECB has long advocated for the euro area. I particularly regret that one of the key aspects of such a quantum leap – greater automaticity in decision-making through the use of reverse qualified majority voting to the maximum extent possible – has only partly been achieved. I therefore believe that, in the medium term, the review clause included in the package should be used to enable further enhancements to euro area economic governance that will contribute to a smoother functioning of EMU.

Reaping the benefits from the euro

The experience of the crisis has shown that participation in a monetary union places important demands on national economic policies. What economic conditions need to be satisfied for a country to fully reap the benefits from adopting the euro? I believe that the fundamental logic of the Treaty, and the convergence framework embedded in the Treaty, remains correct: countries have to make sure that they pursue sound macro-economic policies. They should first and foremost focus on establishing sound fiscal and sustainable macro-economic developments in their own country and complement this with the necessary structural reforms. By doing so, they will actually kill two birds with one stone, as they then also follow the best possible strategy for ensuring smooth integration into the euro area in a lasting manner.

Reaping the benefits of the euro is thus in the hands of the national authorities themselves. Not only can they improve market flexibility, but they can also conduct a well-designed fiscal policy. As I have stressed on many occasions, the best contribution fiscal policy can make to the proper functioning of the euro area is by being sustainable and medium-term orientated. Moreover, fiscal policy can and should also help mitigate undesirable trend growth differentials through “high quality” expenditure and tax policies. In particular, high and inefficient public expenditure can put a brake on economic activity by imposing a high tax burden on the economy and channelling resources into unproductive uses. Let me stress that governments and social partners share responsibility for ensuring that wage determination sufficiently takes into account labour market conditions and does not jeopardise competitiveness and employment. Governments should also be aware that wage-setting in the public sector can serve as a role model for the private sector. And social partners need to take into account the different conditions at the firm and sectoral level, internalising the repercussions of wage settlements on competitiveness and thus employment at their company and in their industry, sector or region. Sufficient wage differentiation would improve employment opportunities for less skilled workers and in regions or sectors with high unemployment. In this respect, excessive regulations – both in labour and product markets – undermine job creation, in particular for young and less qualified workers, as well as for all those who face problems entering the labour market.

Full speech



© BIS - Bank for International Settlements


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