European Monetary Union without Banking - Essay Example

European Monetary Union without Banking or Fiscal Union Cannot Succeed Introduction European Monetary Union (EMU) was formed with the sole aim of providing financial stability to the member countries. The European Central Bank (ECB) became an integral part of the EMU and began setting monetary policy for the EMU. The role of monetary policy is to maintain price stability because it is a crucial necessity for growth of an economy and welfare of the people. ECB has failed in its major objectives as found during post 2008 financial crisis. The paper attempts to find whether the causes of this failure lie in the absence of appropriate fiscal and banking union without which ECB is unable to exert full control on its member countries. Before going into detail as to why and how fiscal and banking union can facilitate success of monetary union, it will be prudent to delve deeper into the aspects that are responsible in creating a state of financial instability in the European Union. It is worth noting that unlike the United States, fiscal measures are not exercised by the EMU and that is where the major crux of the issue lies. Genesis of Crisis EU witnessed a sovereign debt crisis and an unprecedented banking crisis in the recent years. It is important to note that both did not surface in isolation but they were interrelated. Sovereign debt crisis had its genesis in poor fiscal management over several years violating Maastricht Treaty. A fairly large number of Spanish banks are afflicted with their own sovereign debt and because of that have lost their substantial Tier I capital. Thus, banking crisis has its roots, albeit in an indirect way, to the fiscal mismanagement. It is also true that the US subprime crisis did contribute to the woes of the European banks. When seen in terms of the fiscal mismanagement, the genesis of debt crisis is old. Source: http://abehnisch.com/eu-public-debt-crisis/ Between 1999 and 2007, wages in the public sector units in Greece increased by 50 percent. These were much higher when compared with other euro zone countries. The spending also increased manifold due to 2004 Athens Olympics. The unfortunate part was that the Government spending was not yielding matching tax collection for the state. With the years of spending, budget deficit kept on increasing and reached out of proportion. The irony was that much of the borrowing was not revealed because each successive government had to meet the euro norm that restricted borrowing at 3% of GDP. Everything was fine until global financial crisis surfaced in 2008 that exposed many EU countries for their imprudent fiscal policies. Debt levels went so high that it was impossible for the country to repay them. While providing the rescue package, the European Union attached several conditions that further compounded Greece's woes. In May, 2010, Greece was provided with funds of 110bn Euros so that government could pay its creditors. It was soon realized that given funds were not enough and another tranche of 130bn euro was planned. Maastricht Treaty among the member states specifies that total debt should not exceed 60 percent of GDP. Even this norm was flaunted by the member countries considerably. For example, in 2000, Greece had total debt of 103.4% as a proportion of GDP that rose to 145% and 165% in 2010 and 2011 respectively. Italy too had the total debt-GDP ratio of 108% in 2000 that rose to 120% in 2011 (BBC News, 2012). Fiscal Discipline – A Necessity In the above perspective, it is quite obvious that monetary union cannot achieve desired results in the euro zone area as far as the financial stability is concerned. A fiscal discipline is extremely necessary; however, monetary union has no control on fiscal imbalances created by the member states. Cottarelli (2012) from the IMF argues that in view of the current situation and to bring the EU out of crisis, a Fiscal Union is an absolute necessity built on the following criteria. 1. The Fiscal Union can enforce stronger constraints on state deficits and debt creation that will help reduce the fiscal shocks in the economy of the nation and the Union. 2. The Fiscal Union will aim at having a large central budget to help reduce some key economic differences across countries and provide the tools for risk sharing when required. This will bring harmonization in non fiscal policy measures that include setting up of a Banking Union. 3. Fiscal Union will control and restrict unsustainable fiscal imbalances of the member states that eventually impact entire Union. Cottarelli (2012) also argues that self- imposed constraints cannot work in the European Union where cultural and local differences among the labour force are huge. For example, labour mobility in the euro area is limited unlike the US where labour mobility can work toward absorbing fiscal shocks to a certain extent. An effective surveillance on the fiscal matters is necessary and that is not possible without a Fiscal Union. It is necessary to have common accounting standards and timely reporting of fiscal data; besides, having auditing of the reported data so as to prevent the situation that was seen in Greece, Portugal, Spain, Ireland. And this is possible only when all member countries are brought under a common regulatory unit called Fiscal Union for implementing an effective fiscal management across entire EMU. A Case for Banking Union Too Chadha et al. (2012) argue that the Euro needs to be saved. The authors suggest that the lower-tier countries should move out and return after they complete certain structural reforms in the labour market. This is what authors call a ‘reset’ option. Meanwhile the core Euro states should form a full Banking Union. The ECB should work as an independent fiscal monitoring body and a European Sovereign Bankruptcy court. Apart from fiscal policy enforcement through a Fiscal Union, it is necessary to achieve coordination of non fiscal policies as well such as banking regulation, its control and supervision. In order to perform these tasks a Banking Union is a must. Further, it has been realized that in order to provide stability in the EMU, it is necessary that EU must establish a level playing platform for all its member countries to have a single market for all financial services. Banking sector in EMU is heterogeneous and many small and regional banks are involved with serving basic activities such as taking deposits, offering loans and making transfer of payments. Many commercial banks are involved into investment banking activities increasing systemic risk for its citizens. A single supervisory body under the aegis of Banking Union is need of time to carry out structural reforms to provide a resilient banking system across EMU region. Praet (2012) emphasises that a banking union is a necessity for the eurozone but supervision and monetary policy should not be under a single authority. Most European countries are now agreeing on a Banking Union for wider economic integration; however, varoufakis (2013) argues that a Banking Union is not of much use to resolve the current crisis; however, he also agrees that "the Banking Union will eventually emerge" on the survival of Eurozone. Instead, he proposes direct re-capitalisation without a Banking Union and replacing Out Right Monetary transaction (OMT) with ECB bonds. Peel et al. (2012) reports that in October, 2012, EMU leaders have agreed, in principle, to go ahead for a Fiscal Union for the eurozone. Wolfgang Schäuble, the German finance minister, clearly remarked, “We must now take bigger steps in the direction of a fiscal union". There may be several differences on the modus operandi among the member nations yet all agreed on one thing that Fiscal Union is a necessity. National regulators did enforce the banking regulations before the financial crisis yet the fact remains that qualitatively they were not effective in their member countries. When the European Central Bank (ECB) gets control to regulate them then all banks will need to follow the same rules regardless of their operation within the Union. It is obvious that when ECB comes forward and provides the bailout funds or directly re-capitalise them they would certainly ask for more autonomy to regulate them. In the above perspectives, Banking Union is a necessity that can only help monetary union for an effective financial stability in the region. Banking Union imposing a stricter surveillance on the banking industry will also serve the purpose of severing the ties between sovereign and banks. Conclusion Thus, it is amply clear that European Monetary Union will have more effective functionality after having Banking and Fiscal Union to control the banking irregularities and the fiscal mismanagement. European Central Bank in the banking supervisory role will be monitoring the health of all the banks and the risks taken by them within the eurozone. With Uniform set of rules and protections and a common resolution framework in place a possibility to restore financial stability in the region increases. With the Banking Union also in place with a direct watch on smaller or bigger banks within the eurozone, the monetary union will have tightened all loose ends for its effective functioning. References BBC News, (2012). Government annual surplus or deficit. BBC News Business. [Online] Available from http://www.bbc.co.uk/news/business-13366011 [Accessed 11 March, 2013] Behnisch, A. (2012). EU public debt crisis. [Online] Available from http://abehnisch.com/eu- public-debt-crisis/ [Accessed 11 March, 2013] Chadha, J. S., Dempster, M. A. H. and Pickford, D. (2012). The Euro in Danger: Reform and Reset. [Online] Available from http://www.searchingfinance.com/products/books-econ-politics-finance/the-euro-in-danger-reform-and-reset.html [Accessed 11 March, 2013] Varoufakis, Y (2013). European Banking Union: Behind the Rhetoric. [Online] Available from http://yanisvaroufakis.eu/2013/02/09/european-banking-union-behind-the-rhetoric/ [Accessed 11 March, 2013] Praet (2012). ECB's Praet - bank union a necessity for euro zone. www.reuters.com [Online] Available from http://www.reuters.com/article/2012/11/19/ecb-bankingunion-praet-idUSF9E8JA01320121119 [Accessed 11 March, 2013] Cottarelli, C. (2012) European Fiscal Union: A Vision for the Long Run. International Monetary Fund. [Online] Available from http://www.imf.org/external/np/speeches/2012/110112.htm [Accessed 11 March, 2013] Peel, Q.; Carnegy, H.; Spiegel, P. (2012). Fiscal union highlights EU divisions. www.ft.com [Online] Available from http://www.ft.com/cms/s/0/43fcb7fc-17b0-11e2-9530- 00144feabdc0.html#axzz2NKwkcMNy [Accessed 11 March, 2013] Read More