Board member Olli Rehn
Bank of Finland
The UPI-FIIA seminar
Helsinki, 19.6.2017

The real economy matters: Europe from crisis to growth and reform

For the European Union, the past years since 2008 have been a real stress test, characterized by multiple crises. Nevertheless, Europe has been able to muddle through them, and – without underestimating the remaining challenges – the EU is now on a more stable footing.

Today, I would like to start by identifying three trends that dominate the European political and economic scene for the moment.

  1. Geopolitics is back, particularly since 2014, if not already since 2008. Russian power politics and reasonable doubts about president Trump's commitment for Europe underline the importance of moving forward in European security and defence cooperation.

  2. Brexit will be bad, mainly for Britain. However, it has been crucial that the EU has not been consumed by it, and the Union has so far successfully insulated the Brexit mess from the rest of European policymaking. Brexit may also open up the possibility for deepening European integration in issues like security and immigration.
  3. Economically, the Euro area has overcome the crisis and is now growing for the fifth year, since the spring of 2013. The number of jobs has now passed the 2008 peak, and unemployment continues to fall. This opens up new avenues for reform of the euro area.

Ten days ago, the ECB published its latest macroeconomic projections, revising them upwards: the growth projection for this year is now 1.9% and almost the same rate is projected to continue for the next two years.

Despite the much-improved performance of the euro area recently, we should not close our eyes from the remaining fragilities, such as:

  • Unemployment. Although the number of jobs in the euro area has increased by 5 million since 2013, there are very large differences in the unemployment rate across countries;
  •  Debt. Although the aggregate deficit for the euro area is now under 1½%, smaller than at any time after the financial crisis, the level of accumulated debt in some countries is very high. Gross public debt in the euro area in its entirety is also elevated, exceeding 90% of GDP.
  • The quality of the bank balance sheets. Non-performing loans constitute a third major problem requiring a solution. This is affecting Member States very unevenly, with Italy in a particular focus recently.

The post-recession burden means that the euro area still have much work to do. At the same time, we must not forget the lessons of the crisis.

One essential lesson is the macroeconomic significance of the stability of the financial system. This was grossly underestimated before the financial crisis. Now the situation is being remedied with the Banking Union, which has been under construction since 2012.

Another lesson has been the necessity of having a ‘big bazooka’ available as a means of dampening market panics. This is a very Keynesian lesson, and should not be a surprise to anybody: financial markets are characterized by ‘animal spirits’, which are not always rational but sometimes prone to panic. Currently, the big bazooka needed to pacify the bond markets in case of turbulence consists of the ECB and the ESM together. By necessity, these involve a fair share of burden-sharing, even joint liability, sometimes damned by some people.

The near-term focus should be kept on the finalisation of the Banking Union.  Finland supports a strong Banking Union based on the bail-in principle, which is the framework with private sector or investor involvement in bearing losses for bank failures ahead of taxpayers.

Bail-in can be made compatible with financial stability and well-capitalised banks. Legacy bank problems at national level should not be shifted on to the euro area level; the countries should themselves settle them.

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Recently, the political climate has become more positive for new initiatives towards reforming the functioning of the EMU. In late May, the European Commission published a reflection paper on deepening the EMU.

The document contains a two-stage ‘roadmap’, with agenda for each stage (2017–19 and 2020–25) on three building blocks:

First is a Financial Union, which would make euro area financial markets stronger, better integrated, and less dependent on the state of the finances of individual Member States.

The second building block is Economic and Fiscal Union, which would strengthen the stability of Member States’ economies, facilitate their convergence and the sustainability of their public finances. 

The third building block is a further reform of euro area governance and democratic accountability. This would improve the legitimacy of the EMU and make economic governance and policy coordination more effective.

The roadmap includes many proposals that will require a great deal of discussion before any agreement, such as the creation of a European Deposit Guarantee Scheme or risk-free, bond-backed ‘safe assets’ for the euro area. Even if these proposals may appear quite ambitious and even unrealistic to some, it is worth analysing them seriously.

In Finland, we should be prepared for a scenario that the EU reforms will get under way next year. The direction is obvious. It is – also regarding the Economic and Monetary Union – towards deepening cooperation.

In the coming debates, in my view we Finns should not embark on any kind of catenaccio defence, or stay watching from the sidelines; instead, we should seek to influence the destination and journey to where the work for Europe’s renewal could lead in the coming years and decades.

From the Finnish standpoint, I see the following as key issues:

  1. As we are a member of the Euro, we’d better make it sound and solid. There is no particular use for looking back and delving into the issues of the 1990’s like "should I stay or should I go", but instead work for a solid structure for the euro area, which would enable it not only to survive but also to succeed in the 2020’s and into the 2030’s.
  2. We must learn the right lessons from the debt crisis. It is a fact that the worst rock-bottom of the crisis coincided with the market turbulence that was only tamed once the European Stability Mechanism was created and the European Central Bank took up the role of the lender of last resort. The issue of moral hazard is important, but if we focus only on it, we can close the shop. The crisis was not only the result of the sins of individual member states, but of systemic shortcomings, especially in the banking and financial sector. Only once the financial repair got under way did the Euro area start growing again in 2013.

  3. There is the false contradiction between "either federation or death". The Euro area will not become a political federation or transfer union, but it will either not break up just because of not becoming one. Instead, we should aim at building a solid stability union, where any increased solidarity is matched by corresponding responsibility of each member. In other words, reducing financial risks further is a necessary condition for the further sharing of risk – I am thinking of e.g the safe assets proposed by the Commission. But next time, we have to set the bar higher than only ‘muddling through’.

  4. Ultimately, the real economy matters. Member States’ own responsibility for their economic policies – for sustainable growth and employment – is essential. The real economy is decisive, not only the institutions. As there is no political federation in sight, Member States’ own economic policies and reforms will be vital when going forward.

In all reflections, let us recall that, with regard to both the economy and security, Europe’s ability to cope with and overcome the challenges that may arise does indeed matter for Finland. Therefore, it is in our own interest as well to make the Euro area function well and effectively.