27 September 2022

DNB's Knott: Working on progress. On public and private risk sharing in the EMU

Date: 27 September 2022
Speaker: Klaas Knot
Location: “Euro at 20: shifting paradigms?”, Maastricht

Hello everyone.

And happy birthday! Happy thirtieth birthday to the Maastricht Treaty.

What better place to celebrate this birthday than here – in the Statenzaal – the very room where the Maastricht Treaty was signed. I remember this historic event vividly.

Just like I vividly remember what happened only a few years before: the fall of the Berlin Wall.

In a sense, the fall of the Berlin Wall led to the rise of the Economic and Monetary Union.

Because after 1989, Germany once again wished to become a unified nation. But other European nations, principally the French, were hesitant. A unified Germany would de facto set the economic and monetary tone for a lot of other European countries. And so those countries were keen to ensure that a reunified Germany would remain embedded in a united Europe. That is why discussions on the economic and monetary union gained momentum – eventually leading to the deal between Mitterrand and Kohl: unification for you – the euro for us.

And for the past twenty years, the euro has been the very bedrock of our single market. The absence of exchange rates has been an impressive impetus for prosperity – in the entire euro area. Being a unified economic block has brought much stability. And as a central banker, that sounds like music to my ears.

But… indeed, there is a but.

At the start of the EMU, in 1999, per capita income levels between countries differed significantly. It was expected that the EMU would level these differences. It was expected that countries that had catching-up to do would experience faster economic growth. That we would see sustainable economic convergence in Europe. And to some extent this happened. But – here it is – it did not happen quite as across the board as was expected.

In terms of real GDP per capita, we mainly saw east-west convergence. So between the original twelve countries on the one hand and the seven, soon eight, countries that joined later, on the other hand. So it is no wonder that, despite past crises and the pervasive pessimism in some European corners, a lot of countries are still very eager to join our economic and monetary union.

As far as north-south convergence goes, the first decade of the euro demonstrated the expected economic convergence within the original group of member states. But much of that convergence proved unsustainable and disappeared again after the global financial crisis. In 2010, the EMU even suffered a crisis that threatened the very existence of the euro.

This taught us that it is much harder to achieve convergence that goes beyond the initial convergence that comes with the entry to the euro area. This further convergence will only be possible when we address a number of design flaws in the euro area’s construction. Design flaws that the signatories to the Treaty did not expect nor foresee.

As you will remember, the way out of the 2010 eurocrisis consisted of acute, collective help for individual countries and banks – but also the creation of several European institutions to increase the EMU’s resilience. We now have common supervision of major financial institutions, a single resolution fund for failing banks, and the European Stability Mechanism to help when sovereign nations get in trouble. And more recently, we also set up a Recovery and Resilience Facility to collectively and effectively tackle the economic outfall of the pandemic.

So now that the EMU has proven itself to be an adaptive project, where do we go from here?

This is, of course, mainly a political question. And while the eurocrisis was an impetus for improvement, for making progress, we currently find the EMU too often at a standstill. To get past that, the following political question needs to be resolved at the very least – what should be done first: increase risk sharing in the EMU or decrease existing risks within individual countries?

I am a central banker. I look at things from an economic standpoint. And in that capacity I can say that the longer we have a standstill, the more vulnerabilities between euro-countries will grow, the deeper future economic crises will be, the more emergency support will be needed, and the less prosperity we’ll have – all of us.

So for me, as an economist, too long a standstill is not an option. We must go forward. And, whatever way you look at it, going forward means, at least partly, increasing risk sharing. And I mean cross-border risk sharing. This means using the strength in our numbers to absorb possible shocks.

And when I talk about cross-border risk sharing, I have to distinguish between public and private risk sharing. The first goes through governments. The second through credit or asset markets....

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