Translated from The Economist
European Commission President Jean-Claude Juncker likes to compare the area and the euro’s reform to a house that needs repair. ” Fix the roof,” he advises, ” while the economic climate is favorable . “
In preparation, Emmanuel Macron, President of France, and Angela Merkel, Chancellor of Germany, put forward joint proposals for reforms on June 19.
As a result of weeks of ministerial negotiation, they reconciled long-standing differences over the future of the monetary bloc and set the stage for discussion at the broader summit.
In a Macron victory, the Germans agreed on a euro-zone budget. In other areas, notably banking reform, progress is likely to be halted.
The reforms seek to redress the institutional weaknesses revealed during the years following the financial crisis.
Lacking control over interest rates and the ability to devalue their currencies, some countries have struggled to cope with violent economic shocks. Some, like Greece, were trapped in a “doom cycle” in which unstable markets destabilized the governments that supported them, which in turn weakened banks holding government bonds.
At the height of the crisis, a bailout fund was set up for emergency loans to countries that had lost access to the capital market. In 2012, the euro zone agreed to establish a banking union to contain risks and break the cycle of destruction. The European Central Bank now oversees all of the euro area’s consistently important banks. If a bank needs settlement, the Single Resolution Board provides short-term financing and imposes losses on creditors by limiting the cost to the taxpayer.
But five years later, the banking union remains incomplete. Macron is both committed to going through these remaining reforms and going further.
The purpose of the budget proposal for the euro area is to ensure that the economies of the countries continue to converge and help those affected by external events. New prime ministers from Italy and Spain seem to agree.
The Germans, Dutch and Nordic, however, resist the aggregation of risks across the bloc. They fear that fiscally prudent countries will end up subsidizing profligates. Italy, where an earlier version of the new ruling coalition seemed to disregard euro zone spending rules, did not reassure them.
The Franco-German compromise agrees with several proposals from the European Commission. The first involves reforms to the sovereign bailout fund of the euro zone, the European Stability Mechanism (ESM). It would function as a support to your bank resolution board, reinforcing the banking syndicate. And countries that were prudent but suffering an economic shock would have relatively soft access to a precautionary line of financing so that they could seek money before losing access to markets. So far, most of the ESM lending has been for countries already cut off from markets and conditional on the implementation of hard structural reforms.
All this would be a step forward, says Bruegel’s Guntram Wolff. But he thinks reforms must go further. The French and Germans agreed to keep the bailout governance unchanged. To be exploited, finance ministers must reach a unanimous agreement.
National laws mean that the parliaments of some countries, especially Germany, must grant their approval. This could prevent the fund from quickly ending up in a failed bank during a weekend, as may be necessary.
But the Germans insisted on national control, saying they have not hindered decision-making until now. His reserves also thwarted the immediate progress toward a common deposit insurance scheme. Juncker hoped to calm the fears of the Americans with a gradual implementation during which the common fund would lend to national schemes in times of difficulties. His hope that the banking union would be complete by 2019 now seems unrealistic. A commission proposal to create bonds backed by a pool of sovereign bonds was rejected. Without this, banks will have little incentive to diversify sovereign risk.
The Macron Award is a German concession on the euro zone budget. For the first time, the French point out, Germany has acknowledged that macroeconomic stabilization is not only a question of national governments, but a common concern. Although Macron glimpses a budget in the region of several percent of GDP, Merkel is known to want something “very miserly.”
However, as Mr Macron says, it would be a ‘real budget with annual revenues’. He would like to see revenue increase directly, possibly from a financial transaction tax, although this was controversial.
Most of the money would be invested in innovation, helping economic convergence. There is also mention of an unemployment stabilization fund to act as an emergency credit line for national unemployment insurance plans. But such a project, which agrees with German nervousness about tax transfers, may not be enough in deep crises.
MEPs Macron and Merkel can finally agree on the merits of a central budget. But others must now be convinced. Merkel’s coalition partner, the Christian Social Union, expressed skepticism. Dutch Prime Minister Mark Rutte said he sees little point if countries keep their public finances in order. However, even a well maintained roof can cause a leak.