Jacques Cailloux: „The real issue is the inappropriate level of cost of capital in some countries.”
The euro area needs coordinated policies to offset the inappropriate level of the real cost of capital that some countries are facing. This coordination should be in place as long as real convergence across the region has not occurred which may mean for several decades to come. The crisis in the periphery can be largely attributed to more than a decade of too low real rates which resulted in a massive mis-allocation of capital towards unproductive sectors combined with an overheating of these economies. The latter gave the wrong impression that these countries were converging at a rapid pace while they were in fact experiencing an unsustainable boom. None of the current policy proposals address this issue: No debt brake rule or aggressive competition policies would have prevented these bubbles from materialising. The same can be said about policies aiming at harmonising tax rates across the region. Yet there are a number of policy responses that can tackle the problem of an inappropriate real rate of interest across the region: first, fiscal policy can play a role and should be countercyclical. With the real rate likely to be too restrictive for peripheral countries, fiscal policy there should be relaxed. The opposite is true for the 'nordic' countries that are facing an exceedingly too low real rate of interest. These countries should see their fiscal policies turning more restrictive. Second, it is urgent that the supply of credit is also made countercyclical. While some of the macro prudential proposals under Basel III are aiming at exactly that, these measures are unlikely to be implemented soon enough to prevent the next credit bubble. It is also likely that the euro area needs a macro prudential framework tailored to the region which should address specifically those countries experiencing a rapid catching up process fuelled by unsustainable credit growth. New entrants will all face such economic conditions and yet none of the current policy proposals to fix the union will prevent boom/bust cycles for these new entrants. Action on those fronts is urgently required.
Jacques Cailloux is European Chief Economist of Royal Bank of Scotland
Elga Bartsch: „Coordination on structural policies could hurt growth.”
While closer coordination of fiscal policies and financial regulations in the euro area is welcome, there are also some potential pitfalls. Coordination on structural policies could be detrimental to the euro area’s long-term growth perspectives. In my view, the competition for mobile investment capital was one of the key drivers behind Europe becoming more market friendly over the last two decades; it was instrumental in getting corporate and personal income tax rates down and labour markets more deregulated. Instead of ex-ante coordination orchestrated in Brussels limiting this healthy locational competition, I would prefer countries committing to stricter fiscal rules and stricter financial supervision over the course of the cycle so that additional automatic cyclical stabilisers are introduced into the system. With a single monetary policy, national policy levers need be employed more aggressively to prevent countries from diverging too far from the euro area average cycle (notably in good times). An example of such a measure would be countercyclical bank provisioning. Furthermore, member states will also need to deregulate product and labour markets more completely to ensure that other prices (consumer prices, nominal wages, asset prices) being able to facilitate the necessary relative price adjustments in the absence of exchange rate adjustments and that resources can be reallocated more swiftly across sectors.
Elga Bartsch is Chief European Economist of Morgan Stanley.
Marie Diron: „It comes down to each government seeking to ensure sustainable growth.”
While Eurozone countries need to take better account of developments in the rest of the Eurozone, I am sceptical that greater coordination would achieve much. If coordination comes in the form of quantitative rules, experience suggests that it can be useless at best, damaging at worst. It is very difficult to define rules that are crisis-proof as we have learnt over the past couple of years. Defining a set of principles such as counter-cyclical fiscal policy, active regulation of the banking sector and fostering of labour mobility should be in theory positive for growth. But to make sure that these principles are not empty, there must be some enforcement mechanism. That implies that governments would renounce some policy sovereignty which seems unlikely. A set of vague principles with weak enforcement would be damaging in lulling governments that they have taken some measures to prevent future crises. So ensuring a better functioning of the Eurozone probably largely comes down to each government actively seeking to ensure sustainable growth in their own country.
Marie Diron is Head of European Macro Services at Oxford Economics
Marco Annunziata: „Monetary union without fiscal coordination does not work.”
The current debt crisis has shown beyond doubt that having a single monetary policy with completely uncoordinated fiscal policies simply does not work. At a minimum, the Eurozone needs a very simple kind of coordination: a set of truly enforceable fiscal rules, to prevent individual countries from running irresponsible and unsustainable fiscal policies, while allowing room for automatic stabilizers to operate during recessions. This need not—indeed should not—go as far as tax harmonization: some degree of tax competition in Europe is healthy. It would also be desirable to have a coordination system along the lines of the proposed „European Semester”, where the European Commission could assess the area-wide implications of national economic strategies, and recommend corrective measures if needed. This would get us closer to genuine coordination: the EC could for example recommend countries running current account surpluses to try and boost domestic demand to reduce intra-Eurozone imbalances. I am not convinced this is realistic. It would certainly require as a pre-condition a strong set of fiscal rules. Finally, coordination, and even more harmonization is needed on banking sector regulation and supervision, to prevent arbitrage and guarantee a level playing field while minimizing the risk of future crises.
Marco Annunziata is Chief Economist of General Electric
Thomas Mayer: „We need a regime to make the failure of banks and sovereigns possible.”
The last year has impressively demonstrated that a monetary union needs economic flexibility as well as financial and fiscal policy discipline. Without flexible nominal exchange rates and a national central bank as lender of last resort, economic rigidities and a lack of financial and fiscal policy discipline even in small member countries can lead to unsustainable external imbalances and a run-up of excessive private and public debt that may threaten the entire monetary union. What is therefore required is a commitment to increase economic flexibility (especially in labour markets) and financial and fiscal policy discipline. EU bodies have a role to play in pushing for these commitments to be fulfilled. But the most effective tool to enforce these commitments is the threat to be cut-off from the financing of external and internal imbalances. Hence, we need a regime to make the failure of banks and sovereigns possible. This includes an effective bank resolution regime and a debt restructuring regime for EMU member countries.
Thomas Mayer is Chief Economist of Deutsche Bank
Jose Alzola: „Monetary union requires increasing centralization of policies.”
The events of the past year have created an opportunity to take qualitative steps towards economic integration. These steps should include: (1) Increased centralization of fiscal policies, of which a strengthening of the Stability and Growth Pact is just an initial phase; (2) Increased centralization of banking regulation and supervision, much more ambitious than what has been agreed recently; and (3) Increased harmonization of tax, social security and labour legislation to create a level playing field across the area. Under these conditions, the Euro area can contemplate rescue mechanisms for member countries and systemically important banks in liquidity difficulties, as well as an orderly default mechanism in insolvency situations. The steps favoured above would imply a major move towards political integration (empowering EU institutions, such as the European Parliament, while diminishing national sovereignty). But, in fact, the goal behind monetary union was from the beginning to facilitate political integration.
Jose Alzola is Senior Economist at The Observatory Group