At the end of May, the EU Commission will present a reflection paper on the future of EMU. It will likely contain proposals for more fiscal integration measures for the euro area in the medium term aiming to boost member states’ ability to cope with a future crisis.
An often repeated argument brought forward for more fiscal integration in EMU goes like this: The euro debt crisis showed that euro area countries facing a recession cannot sufficiently cope without the support from a centralised euro area budget. But drawing such lessons from the euro debt crisis presumes that this was a typical crisis. It underestimates the fact that the crisis’ deepness in unlikely to reoccur. It had exceptional causes and in parts one-off characteristics, such as:
1. The global financial crisis was a once-in-a-century event. It led to enormous increases in government debt because economies collapsed, large fiscal stimulus packages were needed and banks had to be rescued with expensive aid packages. As a result, the ability of national fiscal policy to act in the euro debt crisis that occurred just shortly afterwards was severely limited. There will undoubtedly be other financial crises in the future. But many reforms should help to prevent a crisis of similar depth.
2. The large interest rate reduction in Southern Europe before and just after the onset of EMU boosted domestic demand and considerably reduced the cost of loans. This contributed significantly to the build-up of a very high level of private and foreign debt, which has been a major reason for the depth and length of the crisis. Such a sharp drop in interest rates in a decent economic situation will most likely not be repeated.
3. The technologically less advanced economies of Southern Europe were severely affected by a strong globalization shock in the last decade by rapidly increasing competition from low-wage countries. After its accession to the World Trade Organization, China benefited from lower trade barriers in Europe and expanded its export market share enormously. The same is true for the countries of Central and Eastern Europe, which obtained better access to the markets of the EU-15 in the course of the EU's eastward enlargement. The competition of low-wage countries will remain, but it will not increase to the same degree in the future. In addition, the Southern European states had time to adapt to the competitive challenges.
4. Towards the middle of the previous decade, labor market reforms and wage restraint in Germany contributed to a growing divergence in EMU regarding wages, prices and competitiveness. During the same time, wages in Southern Europe increased faster than productivity. This divergence contributed considerably to large current account imbalances that also caused the crisis. A new phase of fundamental liberal labor market reforms appears highly unlikely in Germany. In addition, the majority of the Southern European countries have again improved their price competitiveness.
Further reforms in the financial market are needed to limit future crises, such as stricter regulation of the shadow banking sector, or the abolition of the tax privilege of financing debt compared to equity. The ongoing debate about more fiscal integration in EMU threatens to distract from required reforms in other fields that are more important regarding the future crisis resilience of EMU.