Challenging times lie ahead for the eurozone

Stronger tools are needed to ensure success in the event of a new crisis

The editorial board


The eurozone’s fiscal rules are arcane, illogical and a source of frequent friction both among governments and between Brussels and national policymakers © AP


January 1 marks the 20th anniversary of the euro’s launch as an electronic currency. It is good that Europe’s leaders are passing this milestone in a more guarded, less self-congratulatory spirit than was the case in the build-up to the 10th anniversary. In 2008 the European Commission published a report that described the euro as “a potent symbol of our growing political unity” and “a pole of stability for the global economy”. The report was barely off the printing presses before the western world’s financial system was in meltdown. Europe found itself in a sovereign debt and banking sector emergency that lacerated its political unity and raised doubts about the survival of the currency union.

Having come through this test of fire, national governments and policymakers at the European Central Bank, commission and other EU institutions are thankfully alert to the dangers of complacency. For sure, the risk that the eurozone will break up has shrunk since the crisis years of 2010-12. Even the chance that Greece, the area’s weakest member, will drop out has diminished since 2015. Yet these possibilities have not entirely vanished. The reason is that the architecture and policymaking processes of the eurozone remain a work in progress.

These shortcomings apply to European banking union, the eurozone’s fiscal rule framework and the crisis-fighting instruments available in the event of an acute debt emergency in a large state such as Italy. Banking union has made considerable strides with the creation of a single supervisory mechanism, a single resolution authority and regulatory reforms aimed at making Europe’s banks more resilient. However, the slow progress on establishing a common deposit insurance scheme means that Europe’s banking union remains incomplete, leaving the eurozone vulnerable if another sovereign debt and bank crisis were to break out. Strengthening the banking union should be among the eurozone’s highest priorities for 2019.

As far as concerns the eurozone’s fiscal rules, the essential problem is that they are arcane, illogical and a source of frequent friction both among governments and between Brussels and national policymakers. The rules suffer from their emphasis on trying to use a yardstick, a government’s structural budget balance, that is impossible to calculate accurately.

Beyond this, the EU authorities appear to lack the conviction and strength to enforce the rules consistently against recalcitrant governments. This has the pernicious effect of discrediting the rules without deterring some politicians from ignoring their duties to the currency union as a whole. The eurozone needs a more transparent set of rules that encourage governments to reduce public debts and budget deficits, but offer more leeway to countercyclical national fiscal policies when appropriate.

The question of how the eurozone would deal with another full-blown crisis has not yet received a proper answer. The Single Resolution Fund, the eurozone’s bank rescue scheme, is to be allowed access to funds from the European Stability Mechanism, the vehicle for assisting governments. But disagreements persist about whether the eurozone should impose losses on investors by insisting on restructuring the sovereign debt of governments applying for aid in a crisis.

Challenging times lie ahead for the eurozone as economic growth slows, notably in countries such as Italy where debt levels are already too high. It is essential that policymakers should equip the eurozone to fight the next crisis better than they did before 2008.

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