23 April 2018

VoxEU: Analysis of the proposal “A constructive approach to euro area reform” by seven German and seven French economists

Overall assessment and proposals

The team of French and German economists is to be congratulated for the attempt to put together a package of measures that is effective in stabilising the euro area, internally coherent, and politically feasible. That is a tall order and any critic must recognise the scale of the challenge. To conclude, I focus on suggestions as to where the package needs to be extended or adapted.

Much of the underlying problem analysis is correct, although in some areas it is limited. The downplaying of the inherent tendency to competitive and current account imbalances (‘rotating slumps’) is a serious shortcoming. The proposed policy package attempts to overcome the ‘discipline through punishment’ approach, which has manifestly not worked, without far-reaching federalisation, which seems politically infeasible.

At the same time, it fails to adequately address some important issues and the proposals are skewed – notwithstanding the claim to be a marriage of the risk-sharing and disciplinarian approaches – in favour of the latter. The excessive concern with ‘moral hazard’ issues in a number of areas prevents a clear line being drawn under the crisis. Under the various strictures imposed on them (such as higher interest rates and fund contributions), those countries hit hardest by the crisis will struggle to develop, while those that have emerged from the crisis comparatively unscathed will not be so encumbered. Countries facing higher costs will constantly be confronted with the question of whether they are not better off regaining their own monetary autonomy. Thus the future of the common currency will continually be in doubt (Watt 2017).

If the proposals are to be taken as a point of departure, important changes and extensions would be needed, including notably:

• Solutions need to be found to legacy issues in vulnerable national banking sectors with a collective element.
• The European fiscal capacity should not take the form of a rainy-day fund but a lending capacity by the ESM.
• Any creation of junior bonds must go hand in hand with effective measures to ensure that existing government bonds and new issues under the spending rule are risk-free and thus removed from the threat of destabilising speculation.
• National fiscal stances must be set with much greater regard to safeguarding public investment and to ensuring symmetrical counter-cyclical stances at national level and thus their coherence at the aggregate level.
• To this end it is vital to reform the Macroeconomic Imbalance Procedure to ensure it is symmetrical vis-à-vis deficit and surplus countries and its application to the entire macroeconomic policy mix. Koll and Watt (2017) and Horn and Watt (2017) propose developing the new national productivity boards into a platform for macroeconomic expertise and extending the existing Macroeconomic Dialogue (MED) at the EU level also to the euro area and national levels. Alongside fiscal policy, the MED brings in the social partners and the national central banks. Fiscal, incomes and macroprudential policies can be thus be better aligned towards growth and stability-oriented and mutually consistent stances. Ownership of agreed targets is increased. This approach emphasises the preventive rather than corrective approach, and would reduce the need for disciplinary measures inspired by a fear of moral hazard.

Full assessment on VoxEU

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