A More Perfect Monetary Union

WARSAW – The eurozone is often considered an experiment – a monetary union without political unification. Those who make this claim seem to have in mind a model of a single state, which possesses two relevant features: limited fiscal sovereignty for regional and local governments and a substantial common budget from which regions hit by asymmetric shocks can receive transfers. Those who claim that “political union” is necessary for the eurozone appear to focus on the second feature, despite the fact that fiscal constraints on local governments are clearly a typical and important component of single states. In this sense, they ignore the fact that the European Union’s Stability and Growth Pact has been in principle an important component of political union, not its substitute. Indeed, the eurozone’s current fiscal problems do not result from the lack of a large common budget, but from weak enforcement of the Pact. More fundamentally, monetary unions – in a broader sense – have existed not only within single states, but also in groups of sovereign states, the gold standard being the most notable example in history. The experience of such monetary unions offers two lessons. First, they required fiscal discipline in the member states, which was true under the gold standard, with its informal norm of balanced budgets. Second, they existed without any fiscal transfers from a common center, because such a center did not exist. Instead, a great deal of flexibility, including within their labor markets, facilitated adjustment to asymmetric shocks. It is clear that there is no scope in the foreseeable future to extend the EU budget in order to increase fiscal transfers to eurozone members affected by sharp declines in consumption. This would require an enhanced level of European identity, something which the Union’s political elites cannot generate artificially. But the crucial point is not that a large common budget in the eurozone is politically impossible to achieve, but rather that it would not address the main problem: the weakness of the mechanisms safeguarding fiscal discipline in the member states. Instead of looking at the wrong model – that of a single state – the EU and its member states should focus on the conditions required for the proper functioning of a currency union that has no common budget to compensate for asymmetric shocks. First, utmost priority should be given to strengthening the mechanisms aimed at preventing pro-cyclical policies and large fiscal shocks. This requires ensuring the credibility and transparency of the accounting rules that define budget deficits and public debt, with closer monitoring also focusing on the development of asset bubbles, which cause deep recessions – and thus sharp increases in budget deficits – when they burst. Likewise, the European Central Bank’s monetary policy should “lean against the wind” by paying more attention to the development of asset bubbles. As the ECB’s common monetary policy cannot fit the macroeconomic conditions of all the member countries, the eurozone countries need macro-prudential regulations that aim at reducing excessive credit growth. Meanwhile, the Stability and Growth Pact should be strictly enforced, which implies using and strengthening the available sanctions. To be sure, initiatives at the EU and/or eurozone level cannot substitute for stronger mechanisms of discipline in the member states, which are ultimately the responsibility of national politicians and publics. But EU-wide measures aimed at ensuring discipline are necessary to spur the growth of preventive mechanisms in the member states, and such initiatives are largely dependent on the large countries, which thus bear a special responsibility for the developments within the eurozone – and within the EU. Second, beyond strengthening economic institutions, EU countries must accelerate structural reforms to boost their long-run growth prospects and facilitate their smooth adjustment to shocks. The former are necessary to help Union members grow out of their increased public debt, while the latter would help them to address unemployment. Of the many necessary measures in this area, the most important include a vigorous effort to complete the Single Market, coupled with avoidance of economic nationalism at all costs. Moreover, the Lisbon Agenda should be reinvigorated, with a focus on market reforms, and the EU should urgently reconsider measures – particularly regarding climate policy and the drift toward an EU-wide social policy – that risk imposing additional burdens on their economies and/or hamper the flexibility of markets. In this respect, the mode of fiscal reforms is fundamentally important. As EU members already have large tax burdens, further tax increases would weaken the forces of growth. Thus, fiscal reform should focus on reducing the growth of spending commitments, which –given the aging of EU societies – must include raising the retirement age.Finally, rigid labor markets and, more generally, regulatory constraints on prices and on the supply response of the economy, deepen recessionary reactions to various shocks, and contribute to the growth of unemployment. Therefore, labor-market liberalization should be a high priority and another area of focus for the reinvigorated Lisbon Agenda. European elites are fond of exclamations about “European solidarity,” “social cohesion,” and the “European social model.” But no amount of lofty rhetoric can substitute for the reforms outlined here – or obviate the need for them. Leszek Balcerowicz is a former Deputy Prime Minister and Finance Minister of Poland (1989-1991; 1997-2000) and a former President of the National Bank of Poland (2001-2007). Copyright: Project Syndicate, 2010. www.project-syndicate.org