EMU's weaknesses have been partially addressed
The financial crisis has brought to light various weaknesses in the original structure of the EMU. From the outset, there was a fundamental disregard for macroeconomic imbalances and the close interconnectedness between national governments and financial sectors. As a result of these weaknesses, the crisis affected the EMU more deeply than many other developed economies. The consequences are still being felt as various Member States are still facing high unemployment and low inflation.
The EMU's optimum structure continues to be the subject of much debate, with the degree of European integration needed to safeguard a stable currency union being a particularly moot point. Still, numerous improvements were made in recent years. For example, budgetary rules have been reviewed and new rules have been introduced to prevent macroeconomic imbalances. The banking union has reduced interdependencies between banks and governments, while the European Stability Mechanism and other financial safety nets can prevent capital flight. These measures have reduced the likelihood of severe financial turbulence.
Balance between liability and control
It is important to monitor the balance between the liability that member states have for each other's risks and the degree of control they have over each other's policies, to safeguard the EMU's sustainability in the long run. The recently made amendments threaten to skew that balance. With financial safety nets in place, mutual European liability for individual distressed member states has increased. However, compliance with tightened European budgetary rules leaves much to be desired. If a Member State knows it will be bailed out, there is a risk that it will be less keen to pursue policies aimed at preventing problems. This increases the likelihood of economic instability.
Strengthening the EMU
A number of relatively small measures could already improve the balance between liability and control. Compliance with the Stability and Growth Pact and the macroeconomic imbalances procedure could be improved by simplifying the rules and limiting the number of exceptions, ensuring they cover the imbalances with the largest adverse spillovers to other Member States. In addition, enforcement of the rules could be strengthened by assigning a greater role to networks of independent national authorities.
Likewise, private parties should again bear a larger share of the financial risks, thus reducing the need for governments to step in. This requires a mechanism that facilitates the resolution of unsustainable government debt. Also, completion of the banking union by setting up a European deposit guarantee scheme could further reduce the harmful interaction between banks and governments. This requires that risks in banking balance sheets are first reduced, indispensable parts of which will be the resolution of existing non-performing loans and stricter regulation of government bonds in banking balance sheets, for example in the form of higher risk weights.
A stable EMU does not necessarily require even further integration, although this could potentially generate additional economic benefits. For instance, more far-reaching public risk sharing could accelerate a recovery from economic shocks. A key precondition, however, is that extended public risk sharing goes hand in hand with binding agreements on the efforts which individual Member States should make to keep risks in check.