Henrik Enderlein, Jean Pisani-Ferry, and 13 fellow German and French economists join forces.
The euro area has recently seen some good news. A broad-based economic recovery is under way. Significant institutional reforms have been achieved, particularly in the area of banking union. Significant economic reforms are under way in several countries, including in France.
As French and German economists committed to Europe and to the friendship between our countries, we are nonetheless concerned that the euro area continues to face significant fragilities. Addressing these fragilities requires a comprehensive push for reforms. If this effort fails, the chances that a major crisis will reoccur in the euro area in the foreseeable future remain high.
The euro area recovery is fragile for three reasons.
First, euro area stabilisation has relied too much on the European Central Bank (ECB). Subdued inflation induced highly expansionary monetary policy. This has helped euro area countries that were shaken by the crisis to recover. But as price stability is gradually restored, the ECB will remove stimulus, and interest rates will rise, putting pressure on countries that are recovering less vigorously and continue to suffer from high debt levels.
Second, the financial stability of the euro area remains threatened by the legacies of the euro area crisis. Of particular concern is the continuing high exposure of the banking systems of several countries to the debts of their own governments. This means that any difficulties in the sovereign debt market will promptly translate into difficulties for the financial system, and hence the real economy.
Third, the euro area’s instruments for promoting sound policies at the level of each member countries remain blunt and are often ineffective (in particular, in averting public debt accumulation). They are also a source of political tension, and expose the European Commission – which is supposed to enforce these rules – to criticism of being too tough in some countries and not tough enough in others.
Fortunately, the French and German governments have recognised the imperative for EMU reform. Informal discussions started before the German elections, and will hopefully gain momentum in the coming months. The leaders of both countries have expressed support for a Eurozone budget, a European finance minister, and a European Monetary Fund.
Unfortunately, however, both sides have rather different views on what these terms mean. During his tenure as French Economy Minister, Mr. Macron argued for a euro area budget, based on a dedicated revenue stream, that would “provide automatic stabilisation and allow the European level to expand or tighten fiscal policy in line with the economic cycle” (he has since repeated his support for such a budget although with less economic precision). Mrs. Merkel, in contrast, is thinking of a small fund that would support structural reform in Euro area countries. On the European Monetary Fund, ideas are similarly divergent. The German government wants to strengthen the European Stability Mechanism (ESM) so it can engage in tough surveillance of member states’ policies. France wants to give it more financial firepower.
These differences mirror deep divisions between the two countries. German officials have long rejected calls for additional euro area stabilisation and risk sharing instruments, and instead want tougher enforcement of fiscal rules and more market discipline. French officials, on the other hand, have called for ambitious additional stabilisation and risk sharing. They concede that this requires strengthening fiscal discipline at the national level, but reject more market discipline.
If both sides stick to their current positions, the outcome of the incipient Franco-German push for euro area reform is predictable – and depressing in that it would not solve any of the key challenges. It might result in a symbolic, very small Eurozone budget with a “Minister of Finance”, but without a borrowing capacity. The quid pro quo will not be greater market discipline, as the Germans are hoping, but tougher euro area level intervention powers, possibly accompanied by a symbolic strengthening of national fiscal rules.
Apart from allowing both the French and German governments to claim victory at home, such a “small bargain” would accomplish very little. It would not make the euro area more stable. It would not address the fundamental causes of why fiscal rules have not worked well. It will set up euro members for more fights with “Brussels” if it does not go along with better incentives for adopting national policies consistent with European rules. Worse still, a bargain of this sort may induce a false sense of security, hindering needed reforms both at the national and European levels.
To move Europe forward, France and Germany need to aim beyond this small bargain.
First, they will need to expand their discussion to tackle not just fiscal policy. While a Eurozone budget could be helpful for risk-sharing purposes, it is difficult to design appropriately, and there may be legitimate reasons to expand common fiscal resources at the European Union rather than euro area level. But if this is the case, it will become even more important to facilitate euro area risk-sharing through non-fiscal and non-monetary instruments. This will require a discussion on how to resolve the continuing deadlock on European deposit insurance, and how to promote capital market integration, which is underdeveloped in the euro area, particularly compared to the United States.
Second, they will need to do some serious thinking on how to address the legacy problems from the crisis – particularly the large continued exposure of banks to their national sovereigns – which trigger the diabolic loop between banks and sovereigns and destabilise cross-border capital flows. This calls for regulatory curbs on such exposure, which are a natural complement to European deposit insurance. It also requires a discussion on whether, and if so how a European safe asset could be implemented to switch off the diabolic loop.
Finally, and most importantly, French and German officials will need to take a leap of faith away from their traditional positions – while insisting that the legitimate concerns that motivate these positions are addressed. Germany needs to accept the idea of more risk sharing in the euro area – but should insist that this is done in a way that maintains sound incentives and increases the credibility of the no-bailout rule for sovereigns and the bail-in framework for banks. France needs to accept the idea of more market discipline – but should insist that this is done in a way that does not lead to financial instability. And both sides should throw their weight behind a simplification of the devilishly complex fiscal rules of the euro area, including to reduce the need for micromanagement from Brussels.
As economists who speak a common intellectual language – but are also aware of our own national biases – we believe that Franco-German compromise on meaningful euro area reform is difficult, but possible. It should be guided by the objective to strengthen both market discipline and risk-sharing. A key step in this regard is the gradual elimination of the vicious circle between sovereigns and domestic banks. This would both make the euro are more resilient to shocks and support market discipline by allowing a sovereign debt restructuring without a banking panic, and large-scale banking sector restructuring without massive public cost. In the coming months, we hope to contribute our own thinking toward finding practical solutions that meet these aims and support the efforts of the French and German governments to lead and work closely with its European partners and Europe’s institutions in giving the euro area new impetus.
Authors: Agnès Bénassy-Quéré, Markus Brunnermeier, Henrik Enderlein, Emmanuel Farhi , Lars Feld, Marcel Fratzscher, Clemens Fuest, Pierre-Olivier Gourinchas, Philippe Martin, Jean Pisani-Ferry, Hélène Rey, Isabel Schnabel,[Jean Tirole], Nicolas Véron, Beatrice Weder di Mauro and Jeromin Zettelmeyer
This article was originally published in the Frankfurter Allgemeine Zeitung and Le Monde.