John FitzGerald: EMU a successful work in progress
Policy gaps remain, including weak systems for co-ordinated fiscal response to any crisis
When the UK was an EU member, the euro zone only covered just over 70% of the EU economy; today it constitutes 85%.
Economic and Monetary Union (EMU) finally began in January 1999, after a long period of gestation, with the move to the euro coming three years later. I remember our daughter was travelling to the US the day the first euro notes and coins were issued on January 1st in 2002 and we looked in vain in the airport for an Irish euro coin to take with her to show her friends – the ATMs there were only issuing €50 notes!
The story goes that the Central Bank had opened its doors specially that morning (it being a bank holiday) for callers looking for the new notes, and was offering a complimentary glass of whiskey to mark the occasion – but hadn’t reckoned with the numbers who turned up. In the end, they had a sufficient supply of notes, if not of whiskey.
Although a lot of preparatory work had been done to understand how EMU might change how economies operated, there was a lot of unfinished business when EMU went “live”.
The financial crash in 2008 and the deep recession that followed over the following four years, exposed weaknesses in its design, which had contributed both to the financial crisis and prolonged its resolution. As we know, this caused deep damage to economies such as Ireland and Greece.
That experience forced the development of new euro institutions to put EMU on a more robust footing. While there remain important pieces of the institutional jigsaw that still have to be filled in, it is now clear that EMU is here to stay.
Last month Philip Lane, the chief economist of the European Central Bank, published a paper looking back at how the resilience of the euro has developed since it first came into operation. In the 1990s, in the run-up to monetary union, there was considerable concern that the new union would be vulnerable to asymmetric shocks – crises hitting some countries but not others. Despite these fears, no institutions had been developed to provide a backstop if countries or national financial systems ran into major difficulties.
Also, because each country regulated its own financial system, a failure of oversight in one country ran the risk of affecting the whole of the intertwined euro zone.
The financial crisis was an extreme asymmetric shock: it affected some countries, such as Ireland and Greece, very badly, whereas other countries, such as Germany and the Scandinavian states, were much less affected.
Initially the euro zone didn’t have the tools to deal with the crisis, and there was rather weak solidarity between members due to the differential severity of the recession across countries.
However, in the face of the storm, major changes were made to EU institutions. The establishment of the European Stability Mechanism provided emergency funding. The commitment in 2012 by then ECB governor, Mario Draghi, to do “whatever it takes” to protect the euro was also a turning point.
Since then, responsibility for key elements of the EU banking system has moved to Frankfurt. Regulation has been improved dramatically compared to the 2000s.
Weathering the storms
However, there remain significant gaps, including very weak mechanisms to produce a co-ordinated fiscal policy in the face of a crisis.
Crucial to the EMU’s survival in 2010-2012 was that it was clear to all members that the cost of leaving the union at a time of crisis would be extremely high, not just for a country exiting, but also for those who remained.
Having weathered the storms of the 2008 to 2012 period, and developed necessary new institutions, the Covid-related economic crisis has posed no serious problems for policymaking in the EMU. Because all countries are affected by the recession, there has been an appropriate co-ordinated fiscal response, as well as the extremely effective action by the ECB.
The EU Next Generation initiative, where the EU is borrowing to support the worst affected countries, is also innovative, even if it does not turn out to be a permanent feature of the bloc.
Lane has emphasised that the interconnectedness of the euro and the European Union has been further reinforced by Brexit. When the UK was an EU member, the euro zone only covered just over 70 per cent of the EU economy; today it constitutes 85 per cent. This will change the dynamic of economic policy formation within the bloc.
Being outside the EMU weakens the position of countries like Denmark and Sweden. For Ireland, our current chairmanship of the eurogroup of finance ministers has given us an entrée to the top table as evidenced by Paschal Donohoe’s presence at the recent meeting of G7 finance ministers.