Member of the Board of Bank of Finland
At the the Reinventing Bretton Woods Committee seminar “The Quest for Normality in an uncertain World?”, Washington, 13 October 2017
Opening remarks in the session “The European Spring?”
Ladies and Gentlemen,
The title of this panel is quite evocative. It recalls visions of regeneration and new growth.
The title also reminds us of the historic events of 1968, the “Prague spring” and the “Paris spring”. They proved to be short-lived. If there is now a European spring, let us hope its impact is more lasting.
True, there are reasons for optimism. The euro crisis is behind us and economic fundamentals in Europe are strong and improving. For the euro area as a whole, the recovery is now in its fifth year and broad-based in terms of both countries and sectors involved.
Most importantly, the employment situation, which is the Achilles’ heel of European societies, is gradually improving. The euro area unemployment rate is at the lowest level since the end of 2008. The number of employed is growing for the fourth consecutive year.
A suspicious feature of the recovery is that the inflation rate has been very low compared to the ECB definition of price stability (of below but close to two per cent). In particular, “core” inflation, which excludes the most volatile components of food and energy prices, has been hovering around one per cent for several years.
The Eurozone recovery is a result of the positive feedback loop between the growing world economy, the largely completed fiscal and balance-of-payments adjustment, and much improved credit conditions. The expansionary monetary policy of the ECB has been indispensable, and will be needed as long as price stability again is self-sustaining.
As a sign of stronger fundamentals, the current accounts of the ex-deficit countries have also swung to balance or surplus. The Eurozone current account balance shows a sizable surplus, giving scope for increased investment in the coming years.
As a result of the better of economic fundamentals, the political risks to Europe’s progress seem now larger than the economic ones. While the situation in Catalonia remains tense and feeds uncertainty – though with a limited market impact so far – the overall political situation in the Eurozone reflects more constructive undercurrents.
The recovery itself is creating political room for manoeuvre; and at the same time, the European sense of belonging together has strengthened on the face of world events. We should now use the improving economic circumstances and the political window of opportunity for pursuing a serious reform of the euro area, in order to make it a genuine stability union.
The first and foremost priority is to complete the banking union. We have already successfully unified banking supervision under the ECB and created the single resolution mechanism, including bail-in rules and early intervention and resolution instruments for failing banks.
What we still need to do to complete the banking union is two things. First, to create a credible fiscal backstop for the bank resolution fund. Second, to build a common European Deposit Insurance Scheme. To be politically feasible, these remaining elements will require convincing measures of risk reduction, and possibly some co-insurance features in their construction, at least in the first phase.
Going further, we have the Commission’s policy paper, the initiative of the French President and the non-paper of the German Ministry of Finance on the table. None of these alone cannot carry the day.
In reforming the architecture of the Eurozone we would do well to combine the best elements of German and French thinking, which is elegantly described by Markus Brunnermeier, Harold James and Jean-Pierre Landau in their milestone “The Euro and the Battle of Ideas”.
The next reform of the Eurozone architecture should aim at producing a plausible, viable synthesis between, on the one hand, the core principles of “German” economic philosophy, which calls for properly tuned incentives and rules, and those of “French” economic philosophy, which emphasizes insurance and stabilization – I would call this a European synthesis. (And I use the quotation marks deliberately, as these national adjectives are only proxies for two economic philosophies, not owned just by the two countries.)
I found the joint contribution of 15 French and German leading economists, published in September, most relevant in this regard, with its call for a constructive rethinking of the inherited national positions on the question of the future development of the EMU.
That means building a solid stability union that emphasizes each member state’s own responsibility and joint structures to preserve financial stability. The first principle of a stability union is that each member state should primarily be responsible for its own economic policy, and the rules and incentives should be designed accordingly. The second principle is that there needs to be sufficient capacity to joint Eurozone action to preserve financial stability in case of market turbulence. Moreover, it is essential that steps towards further sharing of risk are equally matched by steps to reduce risk. This goes both for public finances and the banking union.
Let me conclude by correcting one flaw that is often seen in the media. The dichotomy of ‘federation or death’ as options for the Eurozone is raised frequently, for propaganda reasons. It is a fake news and has no factual basis. The euro area will not become a federation or transfer union, but it will not break up just because of not becoming one.
Instead, we need both a sense of direction and a sense of realism. The essential guiding principle in reforming the Eurozone economic governance is that we must work to ensure financial stability through co-insurance and risk sharing, while any step towards increased solidarity and merger of economic risk should be combined with increased responsibility and economic sustainability.
In the meantime, we Europeans need to continue reforming our real economies and the European social model. Not nostalgically clinging to the status quo, since that would only lead to a permanent economic decline and social stagnation. Not dismantling the European model, because we believe in the combination of a stability culture, entrepreneurial drive and social justice. But instead, by genuinely reforming and modernizing Europe’s social market economy, for the sake of sustainable growth and job creation.