02 December 2019

European Commission: Quarterly Report on the Euro Area

The report discusses some weaknesses in the EMU’s initial construct, the important reforms undertaken since the European debt crisis, and the challenges still to be addressed in various policy domains directly affecting the functioning of the EMU.

This report was prepared in a context of weakening growth and increased uncertainty globally driven by trade tensions, geopolitical concerns and structural economic factors. Against the background of the financial crisis – the more recent interconnected threats to economic prosperity make it even more clear that completing the EMU’s architecture with a view to shielding it better against adverse shocks remains a priority for the coming years. A complete EMU (i.e., full Banking Union, Capital Markets Union and stabilisation function) would definitely help smooth shocks, delivering better results in terms of growth, jobs and economic security to the people.

This report and its main findings can be summarised as follows. The first section provides a brief overview of financial market developments since the launch of the euro, with a focus on financial integration and stability. The creation of the Banking Union and of the Capital Markets Union were two fundamental steps toward completing the EMU architecture. The overhaul of the regulatory framework for financial markets and institutions, partly due to the weaknesses revealed by the financial crisis, helped stabilise Europe’s financial sector and enhance its robustness to future shocks. However, further efforts are needed, such as to set up a common deposit insurance scheme and a common backstop for the Single Resolution Fund.

The second section provides an overview of fiscal policy and fiscal surveillance over the last 20 years. The primary objective of the EU’s fiscal rules has been to effectively ensure the sustainability of Member States’ public debt. To that effect, the framework has provided valuable stability and maintained overall confidence, in particular by correcting excessive fiscal deficits. Nevertheless, the Stability and Growth Pact has become rather complex and the EU’s ability to coordinate an appropriate fiscal stance for the euro area remains constrained. This calls for an assessment of what is needed to improve functioning of the fiscal framework also in light of recent experiences and potential institutional reforms more broadly.

The third section reviews the main facts and features affecting adjustment and macroeconomic imbalances since the adoption of the euro. It shows that the EMU’s inception had major and long-lasting effects on interest rate spreads and capital flows, which triggered in some cases current account imbalances, strong credit growth and house price bubbles. The financial crisis was followed by the reversal of large current account deficits, protracted deleveraging and recessions in deficit countries, while current account surpluses grew and remained persistent in some large economies. Overall, these developments underscore once again the urgency of completing the EMU with stronger surveillance of macroeconomic imbalances.

The fourth section discusses the evolution of the EMU’s institutional architecture. In the early years the focus was mainly on monetary policy and the functioning of the European Central Bank (ECB) and in parallel the fiscal surveillance framework. However, since the onset of the crisis, the focus has shifted to EMU’s institutional architecture, which – even if with an increasing recourse to intergovernmental solutions – has already been considerably strengthened. At the same time, the rule-based approach to governance may be reaching its limits in delivering optimal policy and a symmetric adjustment for the euro area as whole. Overall, to ensure a more resilient EMU governance, there needs to be a rebalancing towards stronger, more accountable institutions, complemented by a simpler, rule-based framework, as well as deeper reforms to the EMU’s architecture.

This fifth section focusses on monetary policy. Up to October 2008, the ECB conducted monetary policy mainly by adjusting its key policy rates. Over the first decade, inflation averaged 2.2%, while interest rates declined significantly in the Member States that had experienced high interest rates before adoption of the euro. This has been a significant achievement considering the volatile history in the old European Monetary System. Furthermore, during the global financial crisis and its aftermath, the ECB introduced a number of non-standard measures including largescale asset purchases to support monetary policy transmission in certain market segments and additional monetary stimulus once key interest rates approached their lower bound. These measures helped to stabilise the euro area economy but also revealed the weakness inherent in the broader EMU setup.

Finally, the sixth section discusses how structural reforms have contributed to economic growth and resilience, while also emphasising certain politicaleconomy barriers to their implementation. Since the launch of the euro, several modes of EU governance have been employed with a view to foster the implementation of structural reforms, including the open method of coordination, country-specific recommendations, the Structural Reforms Support Service (SRSS), benchmarking, National Productivity Boards, as well as the proposed reform delivery tool and the Budgetary Instrument for Convergence and Competitiveness. Progress with regard to the implementation of structural reforms is slow and uneven across Member States, which in turn calls for continued commitment to growth-enhancing economic reforms at national level and similar policies at EU level.

The euro has delivered tangible benefits such as stable prices, more transparent and competitive markets, as well as increased trade and capital flows. However, this issue of the QREA shows that the deepening of the euro area – which is high on the agenda of the new Commission – is still an unfinished business. The events since the inception of the euro underscore the urgency of completing the EMU with appropriate backstops to deal with major financial crises, a budgetary instrument for the euro area and a new scheme to help countries deal with potentially high unemployment, a genuine banking union to foster a genuine European banking sector and to break doom loops; a capital market union to enhance cross-border capital allocation; and strong and accountable institutions. Completing the EMU’s architecture will allow its citizens to equally benefit from the single currency to its fullest extent.  

Quarterly Report on the Euro Area Volume 18, No 2 (2019)

© European Commission