EC President Van Rompuy: Towards a Genuine Economic and Monetary Union

06 December 2012

Building on the Interim Report and the Conclusions of the October 2012 European Council, this Report provides the background to the roadmap presented at the December 2012 European Council.

The report suggests a timeframe and a stage-based process towards the completion of the Economic and Monetary Union (EMU) covering all the essential building blocks identified in the report “Towards a genuine Economic and Monetary Union” presented at the June European Council. It incorporates valuable input provided by the Commission in its communication "A Blueprint for a deep and genuine EMU – Launching a European Debate" of 28 November 2012. The European Parliament has also made a valuable contribution. As requested by the European Council, this report explores further mechanisms in the context of an integrated budgetary framework, including an appropriate fiscal capacity for the EMU, as well as the idea of euro area Member States entering into arrangements of a contractual nature with the EU institutions on the reforms they commit to undertake and their implementation.

Under the Treaty, the Union has established an Economic and Monetary Union whose currency is the euro. The views set out in this report focus on the euro area Member States as they face specific challenges by virtue of sharing a currency. The process towards a deeper EMU should be characterised by openness and transparency and be fully compatible with the Single Market in all aspects.

This report lays down the actions required to ensure the stability and integrity of the EMU and calls for a political commitment to implement the proposed roadmap. The urgency to act stems from the magnitude of the internal and external challenges currently faced by the euro area and its individual members.

The euro area needs stronger mechanisms to ensure sound national policies so that Member States can reap the full benefits of the EMU. This is essential to ensure trust in the effectiveness of European and national policies, to fulfil vital public functions, such as stabilisation of economies and banking systems, to protect citizens from the effects of unsound economic and fiscal policies, and to ensure high level of growth and social welfare.

The euro area is confronted with a rapidly evolving international environment characterised by the rise of large emerging economies. A more resilient and integrated EMU would buffer euro area countries against external economic shocks, preserve the European model of social cohesion and maintain Europe’s influence at the global level.

Together, these challenges make indispensable a commitment to, and subsequent implementation of, a roadmap towards a genuine EMU. They underscore that ‘More Europe’ is not an end in itself, but rather a means for serving the citizens of Europe and increasing their prosperity.

The actions deemed necessary to ensure the resilience of the EMU are presented therein as a staged-process. Irrespective of their time horizon, all policy proposals have been conceived and designed as elements of a path towards a genuine Economic and Monetary Union. Given the strong linkages between the building blocks, they should be examined as part of a mutually reinforcing comprehensive package. The creation of an integrated financial framework has important fiscal and economic implications and therefore cannot be envisaged separately. Similarly, the proposals put forward in the fiscal and economic policy sphere are closely intertwined. And, as all the proposals imply deeper integration, democratic legitimacy and accountability are essential to a genuine Economic and Monetary Union.

Overview of sequencing

The process could rest on the following three stages:

• Stage 1 (End 2012-2013): Ensuring fiscal sustainability and breaking the link between banks and sovereigns
• Stage 2 (2013-2014): Completing the integrated financial framework and promoting sound structural policies
• Stage 3 (post 2014): Improving the resilience of EMU through the creation of a shock-absorption function at the central level

Single Supervisory Mechanism (SSM)

It is imperative that the preparatory work can start in earnest at the beginning of 2013, so that the SSM can be fully operational from 1 January 2014 at the latest. It will be crucial that the ECB is equipped with a strong supervisory toolkit, and that the ECB’s ultimate responsibility for banking supervision is coupled with adequate control powers. In this regard, establishing an appropriate framework for macro-prudential policy that takes due account of both national and Europe-wide dimension will be important. The ECB has confirmed that it will establish organisational arrangements guaranteeing a clear separation of its supervisory functions from monetary policy.

Single resolution mechanism

Under the single resolution mechanism, resolution actions should follow a least-cost strategy and could be financed according to a pecking order of bailing-in shareholders and some creditors, and relying on the banking industry. The latter would be organised through a European Resolution Fund, which would be a crucial element of the new resolution regime. It would be funded through ex ante risk-based levies on all the banks directly participating in the SSM. The single resolution mechanism should include an appropriate and effective common backstop. This could possibly be organised by means of an ESM credit line to the single resolution authority. This backstop should be fiscally-neutral over the medium-term, by ensuring that public assistance is recouped by means of ex post levies on the financial industry.

Deposit guarantee mechanisms

The history of financial crises has illustrated the destabilising effect uncertainty surrounding bank deposits could have on individual financial institutions and on entire banking systems. The proposal on the harmonisation of national deposit guarantee schemes includes provisions to ensure that sufficiently robust national deposit insurance systems are set up in each Member State, thereby limiting the spill-over effects associated with deposit flight between institutions and across countries, and ensuring an appropriate degree of depositor protection in the European Union. A rapid adoption of this proposal is important.

Guiding principles for the shock absorption function of an EMU fiscal capacity

Irrespective of the approach – macro or micro-economic – the design of such a shock absorption function should rest on a number of guiding principles reflecting also the EMU’s specific features:

• Elements of fiscal risk-sharing related to the absorption of country-specific shocks should be structured in such a way that they do not lead to unidirectional and permanent transfers between countries, nor should they be conceived as income equalisation tools. Over time, each euro area country, as it moves along its economic cycle, would in turn be a net recipient and a net contributor of the scheme.
• Such a function should neither undermine the incentives for sound fiscal policy making at the national level, nor the incentives to address national structural weaknesses. Appropriate mechanisms to limit moral hazard and foster structural reforms should be built in the shock absorption function.
• Linking it tightly to compliance with the broad EU governance framework, including possible arrangements of a contractual nature (see section III below), should be envisaged.
• The fiscal capacity should be developed within the framework of the European Union and its institutions. This would guarantee its consistency with the existing rules-based EU fiscal framework and procedures for the coordination of economic policies.
• The fiscal capacity should not be an instrument for crisis management, as the European Stability Mechanism (ESM) has already been established for that purpose. By contrast, the fiscal capacity's role should be to improve the overall economic resilience of the EMU and euro area countries. It would contribute to crisis prevention and make future ESM interventions less likely.
• The design of the fiscal capacity should be consistent with the principle of subsidiarity, and its operations transparent and subject to appropriate democratic control and accountability. Equally, it should be cost-effective and not lead to the undue development of costly administrative procedures or unnecessary centralisation. It should not lead to an increase in expenditure or taxation levels.

Key elements of arrangements of a contractual nature on structural reforms

In summary, such arrangements embedded in the EU governance framework could rest on the following principles:

• They would be embedded in the European Semester, be consistent with and support the overall euro area policy mix; they would be mandatory for euro area Member States but voluntary for the others, on the basis of thorough, on-the-ground reviews of the main bottlenecks to growth and employment. These reviews would be conducted by the Commission.
• They would cover a multiannual, specific and monitorable reform agenda jointly agreed with the EU institutions and focused on competitiveness and growth that are crucial for the smooth functioning of the EMU.
• Member States and the Commission would be accountable, respectively, to national parliaments and the European Parliament on the content and implementation of their duties under the agreements.
• Structural reforms would be supported through financial incentives and would result in temporary transfers to Member States with excessive structural weaknesses. This targeted support should be financed through specific resources.
• Compliance with the agreements can be ensured by an incentive-based framework. Compliance could be one of the criteria for participating in the shock absorption function of the fiscal capacity. In addition, national contributions to the fiscal capacity could be increased in case of non-compliance.

Ultimately, these far-reaching changes undertaken by the European Union in general and the Economic and Monetary Union in particular require a shared sense of purpose amongst Member States, a high degree of social cohesion, a strong participation of the European and national parliaments and a renewed dialogue with social partners. The openness and transparency of the process as well as the outcome are crucial to move towards a genuine Economic and Monetary Union.

Full report

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