J. de Larosière – President, EUROFI
- Valdis Dombrovskis – Vice-President, Euro and Social Dialogue, European Commission
- Roberto Gualtieri – MEP and Chair, Committee on Economic and Monetary Affairs, European Parliament
- Werner Hoyer – President, European Investment Bank (EIB)
- Klaus Regling – Managing Director, European Stability Mechanism (ESM)
The Euro zone is a currency area composed of heterogeneous countries.
Heterogeneity concerns capital income levels, per capita productivity levels, the productive specialisation of the economies, labour force, skills and demographic settings. At the same time the zone is characterised by a weak degree of federalism. When tensions are manifest, it is necessary to correct the imbalances leading to internal devaluation. This is something that has been applied systematically by the Baltic countries, Spain, Ireland and Portugal with some success. However certain elements of inter-state transfers are probably indispensable to make the EMU work politically, but as long as structural reforms and fiscal discipline take place some form of mutualisation of certain expenditures of the system must not be discarded systematically.
There are indeed different ways of reducing structural divergences and competitiveness gaps on a monetary Union:
- One line of action is to create a federal fiscal incentive for countries that really embark on credible structural reforms: the more fiscal transfers with more conditionality would be the idea.
- A second line of thought, which is not exclusive of the first, is to rely on more financial markets to help the equalizing function. This is what happens in the United States for example when regions are sagging with low productivity investors can step in to improve production conditions. More risk-sharing would reduce the vulnerability of Member States of the Monetary Union to external shocks.
In Europe things are less obvious because of the separation between countries: the languages, the legal and tax frameworks, the obstacles to entry to the markets etc. are different in the euro area and the equalizing hand is more difficult to achieve. Politically the idea of creating a federal fiscal capacity is extremely difficult as long as the core countries of the Monetary Union are still in very different positions in terms of competitiveness.
Years of crisis have posed a threat to Europe's potential for innovative growth and dulled our competitive edge.
Investment in Europe has fallen by 15% since the crisis and its level is still substantially below its long-term "suitable level of around 20-21% of GDP. At the root of the Juncker Plan is the idea of preserving and fostering innovation and competitiveness. With the European Fund for Strategic Investments (EFSI) support, the European Investment bank will provide funding for economically viable projects where it adds value, including projects with a higher risk profile than ordinary EIB activities. In such a context, there must be sensitivity to and recognition of the fact that if more risks are taken, those "more" risks may well translate into more losses. Measures must be taken in order to mitigate those risks.
1. Is it possible to gather countries with different per capita incomes in the European Monetary Union?
The Chair opened the session with some background on the issues to be discussed. The Euro zone is a currency composed of heterogeneous countries. Heterogeneity concerns capital income levels, per capita productivity levels, productive specialisation of the economies, labour force, skills and demographic settings. At the same time the zone is characterised by a weak degree of federalism; the European Union's budget, for instance, is barely about 1% of the GDP of the zone. Economic theory is that countries with very different per capita incomes can co-exist in a monetary union without a systematic bailing-out of deficits, but this is only possible if the lower income countries accept that their standards of living increase only at the pace of their own productivity gains. If they want to catch-up faster than their productivity gains, then the tensions regarding competitiveness and external deficits will create, in a zone with only one currency and no adjustment on the exchange rates, difficulties that will not be bearable in the long run. This suggests that a monetary union of that type is not workable without fiscal and structural discipline and convergence.
When tensions are manifest, it is necessary to correct the imbalances to internal devaluation. This is something that has been applied systematically by the Baltic countries, Spain, Ireland and Portugal with a fair degree of success. However it is worth remembering that the existence of a monetary zone will not erase difficulties. Actually, the existence of the zone illustrates its differences, divergences, and heterogeneity. Therefore, there must be mechanisms to correct this if the zone is going to work out without entering into the impossible tensions of countries wanting to know who is ultimately going to pay. This clear image of how it would work in theory also has its social and political limits. Therefore, some elements of inter-state transfers are probably indispensable to make it work politically, but as long as structural reforms and fiscal discipline take place some form of mutualisation regarding some expenditures of the system must not be discarded systematically.
A policymaker stated that defining the actions required to ensure convergence within an economic and monetary union was one of the key questions that the Five Presidents' Report published on June 2015 tried to answer. Indeed the President of the European Commission, together with the Presidents of the European Council, the European Parliament, the ECB and the Euro Group, produced a report on the deepening of the Economic and Monetary Union and which examined what has been achieved so far, what elements are missing, and what needs to be done first.
This document lays great emphasis on the economic convergence issue because if the EMU is to be successful it requires in particular a process that effectively ensures convergence among the different Member States in the Euro zone.
2. Some important steps have been taken during the last few years to strengthen the Economic and Monetary Union (EMU).
First the fiscal and macroeconomic governance of the EU with the European semester cycle has been strengthened. It focuses not only on the fiscal side, but also on the macroeconomic imbalances following the Macroeconomic Imbalances Procedure (MIP). According to this policymaker, this ensures that the rules of the stability and growth pact are actually being enforced, which unfortunately was not really the case before the crisis. This explains why imbalances accumulated in a number of Member States before 2007-2008. Second, it also changes the thinking of the Euro area Member States which increasingly see their economic and fiscal policies as part of the common concern, as should be the case in an economic and monetary union.
The second important step is related to financial backstops. They did not exist before the EU sovereign crisis. Several tools needed to be developed on an ad hoc basis, as a response to this crisis. The result was the setting up of the European Stability Mechanism, which provides temporary fiscal support for Member States in difficulty against necessary policy conditionality. Also monetary policy instruments were created such as Outright Monetary Transactions – the ECB's commitment to buy Member States' bonds in the secondary market in unlimited quantities if necessary. Recently, the European Court of Justice confirmed that Outright Monetary Transactions are within the mandate of the ECB. So this instrument is another important backstop which can prevent the crisis from spreading and stop any financial panic or speculation.
Third, the Banking Union is gradually weakening the link between banks and sovereigns. A number of significant elements have been introduced like the Single Supervisory Mechanism and the Single Resolution Mechanism. A Single Resolution Fund is now being established.
Thus, a number of actions have been carried out in a relatively short time as regards the Banking Union. The Economic and Monetary Union is certainly now much more resilient to economic shocks than it was just some five years ago, and this is actually recognised by markets. In the recent Greek crisis, contrary to 2010/2011, there were very few spill-over effects. The markets saw Greece as an isolated case and they trusted that the stability of the Euro area as a whole was not in question. This does not mean that everything has been done. On the contrary the Five Presidents' Report outlines a number of directions of work needed to continue to strengthen and deepen the Economic and Monetary Union.
The Five Presidents' Report outlines a number of directions of work needed to continue to strengthen and deepen the Economic and Monetary Union.
The Five Presidents agreed on a roadmap for implementation that should consolidate the euro area by early 2017 (Stage 1, or “Deepening by doing”), as a stepping stone towards more fundamental reforms in stage 2, or “completing EMU”. The long term aim is to complete the EMU by 2025.
The short term objective is focusing on ‘deepening by doing'. Indeed the existing instruments of the European Semester need to be improved and strengthened The revamping of the European Semester includes a more effective use of the Macroeconomic Imbalances Procedure. In this perspective a proposal for setting up a national network of competitiveness authorities in Member States, with a mandate to follow both wage and non-cost competitiveness developments in Member States was suggested. In the fiscal area, the creation of an Advisory Fiscal Board that would coordinate the work of national Fiscal Councils has also been proposed. Indeed in a monetary union, the exchange rate instrument is no longer available as a tool to restore competitiveness. It is therefore necessary to follow national competitiveness developments very closely in order to avoid crises.
The second important direction of work is on the Banking Union, this public decision maker stated. While a number of measures have been taken, there are still some elements missing. A full transposition in all Member States of the Bank Recovery and Resolution Directive (BRRD) has to be achieved without any delay. In addition while a Single Resolution Fund has been decided and is gradually financed by the banking sector, Member States need to provide – as they agreed - interim financing for this Single Resolution Fund, until a decision on the backstop has been taken.
The third, and probably the most controversial issue, is the European Deposit Insurance Scheme. The Banking Union, ideally, also requires depositors' confidence in banks not to depend on the financial situation of individual Member States. The Commission is proposing to move in two stages. In the first stage, there would be a move towards a reinsurance scheme for national Deposit Guarantee Schemes, and the second stage would be the creation of a European Deposit Insurance Scheme. The European Commission is starting consultations with Member States on this subject, as they appreciate that there is some concern regarding this initiative.
Fourth, the social dimension of the Economic and Monetary Union when macroeconomic analysis is being performed has to be strengthened. A greater role will be given to the social and employment indicators in this analysis. It will also begin setting some minimum social standards across the EMU, and across more broadly speaking the EU, which initially can be done via the European Semester and via country specific recommendations, with a focus again on convergence and a decrease of inequality.
There are other elements which also go in the direction of convergence such as the European Fund for Strategic Investment which will support projects in infrastructure, research and innovation. But this is a separate topic to be discussed. Last but not least financing from capital markets in addition to bank lending should be facilitated in order to contribute to the relaunch of investment.
These are the actions which can be implemented in a relatively short period of time. These Stage 1 initiatives should not be seen in isolation, but rather as stepping stones towards the second stage, starting as of 2017 and lasting until 2025.
In stage 2, more far-reaching measures would be agreed upon to complete the EMU's economic and institutional architecture. This will inevitably involve sharing more sovereignty and solidarity and will have to be accompanied by strengthened democratic oversight. To prepare the transition from stage 1 to stage 2 of completing the EMU, the Commission will present a White Paper in spring 2017, assessing the progress made in stage 1 and outlining the next steps needed to complete the EMU in stage 2. In order to inform people about the preparation of the White Paper, the Commission will facilitate a wide consultation with citizens, stakeholders, European and national parliaments, Member States, regional and local authorities about completing the EMU. Public debates should be organised across the EU in 2016. Finally, the Commission will establish in mid-2016 a group of experts to explore the legal, economic and political preconditions regarding the more long-term proposals as outlined in the Five Presidents' Report.
3. Combining one currency, national budgets and full employment by providing countries making the structural reforms with incentives e.g. assistance with conditionality.
Another policymaker agreed that thanks to what has been done in recent years, the EMU has shown a level of resilience far higher than foreseen by many analysts. The Greek crisis was in theory the perfect storm and finally this crisis showed that the integrity of the Euro zone could prevail. This was not only thanks to the mechanisms that were put in place. It was of course crucial that the ECB should start to do what it is doing, and setting up the ESM and so on. But the speaker insisted on the political resilience shown during the crisis, an ingredient that too often economists and analysts do not take into account fully enough.
It is often suggested that a trilemma occurs when it is not possible to have at the same time financial stability, integration and national sovereignty on budgets. However, the speaker does not believe this is the case because actually these conditions do exist and yet the trilemma is not producing its negative consequences. But there have been other problems and dilemmas to which solutions, sometimes temporary, have been found.
The first dilemma is that there cannot be, at the same time, irreversibility of the euro, and a really substantial no bail-out clause; Thus a real possibility of sovereign default, and a lack of a federal budget sufficient to provide essential services for the people are not compatible. So the political solution agreed during the Eurozone crisis was a bail-out mechanism with conditions (e.g. the set-up of the ESM). The first word to overcome this dilemma was 'conditionality', and behind that the ECB with the OMT programme.
The second difficult dilemma was to reconcile automatic and full fiscal discipline, structural reform and investment, which appeared to be very difficult. This has been solved so far with the help of incentives, with the use of flexibility and conditionality while keeping the fiscal rules.
Flexibility is a way of using the rules in order to create a positive incentive between fiscal discipline, investment and structural reform, which then triggers a virtuous circle. The ideas of 'conditionality' and 'incentive guarantees' which help to solve this dilemma are taken into account in the Juncker Plan. The idea is to move a limited part of the Union budget from grants to loans, and perform a function of loss absorption capacity in order to address market failure.
On the one hand, it is important to implement a capital markets union to boost private investment and there is a huge amount of financial resources that potentially could go to investment. This is the reason why it is necessary to do all that is being done to encourage them. In this perspective, the creation of an infrastructure asset class and the revision of Solvency II rules to give insurance companies better incentives seem indeed urgent. On the other hand, there are still market failures but the European Fund for Strategic Investment (EFSI) represents an appropriate way to address them and allow the EIB to keep its AAA rating while going for more risky investment and, potentially, to trigger investment throughout the Union.
The progress achieved so far is based on a temporary solution that requires having behind it the ECB, which potentially might be able to do whatever it takes. Greece is a positive case of how conditionality might work. The flexibility concept might encourage very ambitious and intense structural reforms and at the same time a sustainable and more permanent fiscal discipline, while taking into account the economic cycle and the need to have investment.
However, there are two risks involved in not fully combining short term measures: those that are "improving by doing", and long term measures as proposed by the 5 Presidents' report. First, the short term measures must be implemented. The speaker was concerned by reports that some Member States are planning a pre-emptive strike against the European Deposit Insurance Guarantee Scheme. It is understandable after what has happened in Greece. However this has nothing to do with the fact that completion of the Banking Union is necessary, and must start not by inter-governmental agreement, but by community legislation to begin building up a common deposit insurance guarantee scheme.
Another issue is how to trigger and favour a more binding economic policy convergence and more binding commitment to structural reform. Fiscal councils and competitiveness councils cannot substitute for the Commission; creating additional bodies only creates more confusion according to this public decision maker. There cannot be a final veto right on the national budget, it is constitutionally impossible and would require a really huge Treaty change. So other mechanisms must be developed to have binding commitments to structural reform and the respect of fiscal discipline.
Lastly, even before embarking on an ambitious Treaty change, a mechanism of increasing fiscal capacity can be built, performing certain functions, and giving substantial incentives in respect of certain economic policy convergence targets that then become binding. In this route towards a more permanent solution the ESM has potentially an important role to play in this respect.
The Chair summarised that the basic issue is how can there be national budgets, one currency, and full employment without the whole thing breaking up. The answer suggested by the previous speaker is to provide incentives for countries to make the structural reforms that are at the very heart of the long term viability of the Union. These incentives are conditionality, assistance with conditionality, etc.
4. More risk-sharing would reduce the vulnerability of Member States of the Monetary Union to external shocks
A policymaker observed that now, six years after the crisis broke, it is the perfect moment to analyse what worked and what did not work in the euro area, and where there is a need for improvements. To do so, it is essential to keep political reality in mind, because many measures that may seem desirable might be very difficult to implement, because they would require EU Treaty changes.
There are significant divergences in per capita income across the EU and the euro area. That, in itself, is no problem. The Economic and Monetary Union (EMU) can work with these differences. The Baltic countries are a good example that shows that it can work smoothly. With the right policies, poorer countries will catch up and that has been what happened in recent economic history. All Europeans want to promote this process of catching-up and convergence.
While the EU budget is small, the poorer EU countries receive 3% of GDP every year as a grant, which is already significant.
Fiscal transfers can help in that process if they are designed well. There have also been examples of fiscal transfers that were not used efficiently and therefore did not contribute to this catching-up, but fiscal transfers can be made in the right way and then be helpful. Traditionally this has happened thanks to the EU budget. The EU budget is small, but for poorer countries the net benefits they receive from the EU budget can be big. Typically, the poorer EU countries receive 3% of GDP every year as a grant, not like an ESM loan that needs to be repaid. It is a grant, 3% of GDP; that is a large amount and we may even get to some absorption limits here, if we want to increase that substantially. The Juncker Plan will help and everything the EIB does in these countries will also help with the catching-up process. All that happens during normal times and it has been going on in the EU for 50 or 60 years.
During the crisis of the last few years, new instruments have been created, the EFSF and the ESM. Through lending with conditionality, significant transfers of a special type have been provided to the borrowing countries. The benefit for the borrowing countries is enormous, because the lending terms are so beneficial. For example, in Greece the lending has been for the last 32 years on average, at about a 1% interest rate, and there is even interest deferral for the first 10 years. This provides savings for the Greek budget equivalent to 4% of GDP every year. It is a huge benefit without creating costs to the tax payer in the creditor countries (although national budgets do take on risks) – that is the beauty of creating the ESFS and the ESM. This works in a crisis and can play an important role in bringing these countries back to debt sustainability.
In the light of this crisis mechanism, and in contrast to previous speakers, the speaker did not consider that there were any convincing arguments for it to be essential for the good functioning of the EMU to have permanent transfers. What is more important at this juncture for the well-functioning of the EMU is to strengthen risk sharing via markets. Risk-sharing is a term that describes instruments that lead to the smoothing of income and consumption. More risk-sharing will reduce the vulnerability of Member States of the Monetary Union to external shocks. It is known from the United States' experience that their risk-sharing across the States of the US is much more developed than in Europe. Interestingly, it does not happen very often through fiscal instruments, which have a minor role in the US; it happens mainly through market mechanisms.
It is therefore important to complete the Banking Union and to start work on the Capital Markets Union. It is really important in the future for the smooth functioning of the Monetary Union. The more successful this is, the less need there will be for fiscal transfers to embark on risk sharing; there is a trade-off. If the Banking Union and the Capital Markets Union prove unsuccessful, maybe ultimately more fiscal transfers will be needed, and this is an important consideration for some of the Member States.
Finally, if there is a focus on the Banking Union and the Capital Markets Union, it might still be useful to have a limited fiscal capacity for the Monetary Union, although this will be politically difficult. However, there are ways to achieve it that do not lead to permanent transfers and do not imply debt mutualisation and these can be addressed without any EU Treaty change. That would be a more limited agenda, even in the short run, but is and could complement the Banking Union and the Capital Markets Union. There exist good examples in the US of how this risk sharing can be done through limited fiscal transfers in a non-permanent way.
A public decision maker agreed on the importance of private risk sharing. That is why there is such a strong commitment on CMU and on the completion of the Banking Union. Realism suggests or recommends not to even think of a huge federal budget with permanent transfers. However, it is possible to think about this in a moderate way within the current Treaty, without embarking on an ambitious Treaty change, just to start building up a fiscal capacity for a non-permanent transfer function, including conjunctural unemployment provisions.
In Europe the equalizing hand is more difficult to achieve.
However the moderator stated that In Europe things are less obvious because of the separation between countries: the languages, the legal and tax frameworks, the obstacles to entry to the markets etc. are different in Europe and the equalizing hand is more difficult to achieve.
Politically the idea of creating a federal fiscal capacity is extremely difficult as long as the core countries of the Monetary Union are still in very different positions in terms of competitiveness.
With EFSI support, the EIB Group will provide funding for economically viable projects where it adds value, including projects with a higher risk profile than ordinary EIB activities.
Another decision maker asserted that the European Investment Bank (EIB) is the Bank of the EU and not the Bank of the Euro zone. Therefore, the convergence issues in the Euro zone apply in almost the same way to the European Union in general. The EU Bank was founded by the Treaty of Rome with a clear mandate to contribute to the completion of the internal market and to the economic convergence between Member States. In the first decades of the European integration process, we can stress that convergence was one of the biggest success stories. With the beginning of the financial crisis this process stopped and even began to regress in some areas.
Years of crisis have posed a threat to Europe's potential for innovative growth and dulled our competitive edge.The studies carried out prior to the establishment of the Juncker Plan revealed that since 2007 there has been not only a tremendous investment gap in all parts of Europe, but also, for the last 18 years, an innovation gap. Having such a gap in innovation, research and education expenditures over two decades compared to the main competitors in Asia, South Asia, South-east Asia and North America, leads to a competitiveness problem. All Member States of the European Union are facing this competitiveness problem but in a very differentiated way.
The European Investment Bank has to address these issues. As the European Union's bank, about 90% of its funding is directed towards promoting sustainable growth and job creation in the Member States. Financing research, development and innovation, as well as education and training, is one of the EIB's central remits. This includes support of regional policies.
The EIB looks at the quality of the projects and must concentrate on taking innovation and competitiveness as one of the key criteria for allotting loans, guarantees and equity, because only with a strengthened investment activity in the weaker countries, and with a stronger focus on innovation and competitiveness, will it be possible to reorganise convergence.
Three years ago liquidity was a problem and the Bank was granted a capital increase. Nowadays, there is no liquidity problem; the problem is risk-bearing capacity. Therefore, the Juncker Plan is really a courageous step towards a better use of the EU budget. This paradigm change from grants to loans, from subsidies to guarantees, is a big step forward, enabling a multiplication of the means that are available in the EU budget, from which weaker Member States benefit at the level of 3% of GDP. This can be leveraged with loans, and this should be carried out more.
With the Juncker Plan, the Bank can go to the higher risk categories. Some people in Europe talk about the need to take more risk, but they do not spell out what risk-taking means. Risk-taking means, ultimately, that a project might incur a loss. This can be managed with the risk premium – overall it will be balanced – but there will be losses. This is a political risk for those who are responsible. Talking about more risk-taking seems easy, but actually doing it at the end of the day is quite a challenge.
There is often a fundamental misunderstanding of the European Fund for Strategic Investments (EFSI), which is designed to leverage capital of up to EUR 315 billion for viable growth-promoting projects in Europe over a period of three years. The EFSI addresses a specific relatively small part of the Bank's business, but brings new clients. They approach the Bank about the Juncker Plan, to ascertain if the budget guarantee can apply to their project. After considering the criteria which Parliament and the Commission and Council have agreed on, it may be that these are not met at all by the project, but the regular portfolio may fit their needs perfectly. So, EFSI provides an introduction and it is a great opportunity but it is not the end of the story when it comes to addressing questions of competitiveness, innovation and convergence.
The Chair summarised the discussion, highlighting the fact that there is a short term process, and a longer term one to deepen the EMU, and that there is a need to complete the on-going work on the Banking Union and on the Capital Market Union. He insisted on the importance of implementing structural reforms, which can be helped by some form of conditionality when giving assistance. He also emphasized that competitiveness is now a key element of the survival of the zone.
The discussion stressed the importance of present budgetary transfers, which should not be diminished, because on a global plane they may look very small, but on a beneficiary plane they are really substantial. Fiscal transfers are not going to be the solution, but rather more risk sharing through the markets, which is a very interesting notion, in a way giving supplementary reinforcement to the CMU argument.
At the root of the Juncker Plan is the idea of preserving and fostering innovation and competitiveness. There must be sensitivity to and recognition of the fact that if more risks are taken, the “more” risks may well translate into more losses. Measures must be taken in order to mitigate those risks.
By W. Hoyer – President, European Investment Bank (EIB)
By J. Manuel González Páramo - Board Member, Banco Bilbao Vizcaya Argentaria (BBVA)
By T. Wieser, Chairman of the Eurogroup Working Group and the Economic and Financial Committee, Council of the European Union
By A. A. Weber - Chairman of the Board, UBS Group AG
By L. M. Linde - Governor, Banco de España
By K. Regling - Managing Director, European Stability Mechanism (ESM)
By R. Gualtieri - MEP and Chair of the Committee on Economic and Monetary Affairs, European Parliament
By J. de Larosière – President, EUROFI
By J. Guill - Director General, Commission de Surveillance du Secteur Financier (CSSF), Luxembourg
By G. Reinesch – Governor, Banque Centrale du Luxembourg