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Article by the Bank of Greece Governor Yannis Stournaras published in the 100th edition of “The Bulletin” (OMFIF): Addressing reversal of financial integration

15/01/2019 - Articles & Interviews

Delay in adjustments only magnifies Europe problem

Much has been done in recent years following the Greek debt crisis to improve the functioning of European economic and monetary union. Key initiatives included the provision of intergovernmental loans to Greece, establishment of the European Financial Stability Facility (and its successor, the European Stability Mechanism) and the creation of the (still incomplete) banking union.

There has been, too, the application of stricter rules on banking regulation and supervision, the establishment of the European Systemic Risk Board and the development of appropriate macroprudential instruments to identify and address system-wide risks. The European Central Bank developed new monetary policy instruments to deal with low inflation and growth, and the Single Supervisory Mechanism assumed responsibility for all systemic banks in the European Union, thus addressing the home-bias issue in supervision.

More recently the European Commission, in view of the Multiannual Financial Framework for the period 2021-2027, tabled proposals to establish a Reform Support Programme and a European Investment Stabilisation Function. The new EU budgetary tools aim to bolster stability in times of stress through investment continuity and providing incentives for domestic structural reforms.

Nonetheless, the architecture of EMU is still, in many respects, incomplete. Euro area policy- makers cannot rely solely on ECB interventions. It is essential to ensure that the Commission’s macroeconomic imbalances procedure operates more symmetrically both for member states with external deficits and for those with external surpluses. To date the burden of adjustment has fallen, to a large degree, on member states with current account and budget deficits, such as Greece on the eve of the crisis; member states with high current account surpluses could have responded more appropriately.

Since the crisis, policy-makers have observed a home bias in investment and a flow of euro area excess savings towards the rest of the world rather than within the EU. This has led to a reversal of the previously achieved financial integration and income convergence among euro area countries.

The priority, in these circumstances, must be to complete the banking union with a European deposit insurance scheme, as well as the capital markets union. This will restore intra-European financial flows, improve stability in the banking sector and promote private risk-sharing in the EU. In this context, the role of the ESM could be enhanced to support banking union with a backstop facility.

EMU should enhance public sector risk-sharing by creating a centralised fiscal stabilization tool. The Commission’s proposed European investment stabilisation function could fill this role. Other suggestions involve a European unemployment insurance scheme and the issuance of European ‘safe’ bonds. These ideas deserve policy-makers’ attention.

With regard to member states, national ownership and credible implementation of country- specific recommendations is crucial for promoting economic policy coordination and risk reduction. National policies should focus on structural reforms to improve the flexibility of domestic markets and reduce vulnerabilities in the financial sector. This should facilitate the adjustment of these economies to future shocks. They should also implement sound pro- growth fiscal policies that allow for stabilisation over the business cycle and ensure debt sustainability.

Solidarity in Europe

Policy-makers can draw several key policy messages from the Greek crisis. First, delaying necessary adjustments only magnifies the problem, which will then have to be addressed later on less favourable terms. Second, the proper sequencing of the reform programme as well as ownership (mainly by the government but also the main opposition parties) is key to the adjustment’s success.

Third, political solidarity and greater risk-sharing in the euro area to address large asymmetric shocks are of major importance. Pointing fingers at countries in difficulty only propagates populist voices on all sides.

Fourth, private and public risk- sharing should be enhanced by moving forward with the banking and capital markets unions and by creating a centralised fiscal stabilisation tool. To avoid moral hazard, risk-sharing should go together with risk reduction and close economic policy coordination. Moreover, countries need to improve income convergence and ensure that economic rebalancing operates symmetrically.

Last but not least, a final point on Greece: to bolster investors’ confidence in the prospects of the Greek economy and to be able to refinance maturing debt on sustainable terms, the government must continue to implement reforms and avoid reneging on programme-related commitments.

The years since the debt crisis have been tremendously difficult for the euro area, but the European project endures. The firming up of EMU must be policy-makers’ priority in the years to come.

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