Vox EU: Riding through the storm: Lessons and policy implications for policymaking in EMU

12 January 2020

In December 2019, Marco Buti left the position of Director General for Economic and Financial Affairs at the European Commission at the end of a rough journey through the crisis and its aftermath. In this column, he draws the main lessons out of five key moments in the crisis for the completion of EMU and the appropriate policy mix in the euro area.

Mr Buti tried to encapsulate both a sense of this journey through the euro crisis as well as his policy conclusions in a CEPR Policy Insight by focusing on selected past episodes, some well-known, others less prominent.

The ‘moments’ he has chosen are the following:

• Latvia, one of the ‘Baltic Tigers’, asking for financial assistance in November 2008, which could be seen as a prequel of the crisis in the euro area, with the sudden stops after the build-up of large imbalances and deep-rooted bank vulnerabilities.
• The G20 Meeting in Toronto in June 2010 where policy authorities (though with different degree of enthusiasm) ‘declared victory’ over the financial crisis and decided to start withdrawing the fiscal stimulus with a commitment to halve their deficit by 2013 and stabilising the debt ratios – a decision which in retrospect proved largely premature and economically very painful.
• The Deauville meeting in October 2010 between the then French President, Nicolas Sarkozy, and the German Chancellor, Angela Merkel, where a decision was made to bail in sovereign bond holders, which is widely accepted as having been pivotal for the euro area crisis.
• Mario Draghi’s speech at Jackson Hole in August 2014 which started to change the narrative on euro area policy mix, with a call for fiscal stimulus and structural reforms to be deployed side by side with monetary expansion.
• As an ‘extended moment’, the developments in Greece, starting in 2010 with a dramatic revision of the Greek fiscal accounts, subsequent loss of market access and the need for the EU and the IMF to intervene in the context of a generalised loss of trust, culminating with the ‘Grexit’ debate in summer 2015 and Greece successfully exiting the programme in August 2018.

A reading across these episodes and the ensued policy responses lead him to draw eight lessons for European policy coordination and governance:

• The way in which the crisis unfolded tainted the narrative on its nature. Because of Greece’s fiscal crisis, also the other countries were viewed through ‘fiscal lenses’, which he believes to have been a mistake.
• Financial crises even in small countries can have pervasive effects and a high potential for contagion. This contagion risk was not perceived at the time.
• Financial markets operate according to ‘horizontal and vertical lines’. Financial markets do not exert gradual pressure on borrowers, or, in other words, market sentiment change rapidly from benign neglect to extremes.
• A certain amount of risk sharing is needed in EMU: either via national budgets or via the ECB balance sheet.
• Monetary policy cannot be the only game in town. There is a growing consensus that today, with monetary policy facing increasing constraints, a more active role of fiscal policy, in particular by countries with fiscal space, is needed.
• Achieving an appropriate euro area fiscal stance only via horizontal coordination of national policies is exceedingly difficult.
• EU-level decisions should be insulated as much as possible from domestic political economy considerations. 
• Programme work exposes to political risks.

As to the architecture of EMU, Mr Buti suggests to do the following:

• Complete the Banking Union.
• Set up a European fiscal stabilisation capacity.
• Increase the democratic accountability of European integration.
• Strengthen the international role of the euro.

Full article on Vox EU

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