The chapter examines how it is possible to design a mechanism to relieve the well-known problems of the incomplete Economic and Monetary Union (EMU) and thus reduce its costs. A monetary union can be very fragile and governments of member countries face serious adjustment problems, especially when hit by large, permanent asymetric shocks This leaves the EU with the problem of unsustained debts and fiscal unsustainability. This chapter explores the possibility the EU becomes a fiscal union i.e. “full/complete monetary union” by focusing on the EMU agenda of the EU and evaluating future challenges. In light of findings, some policy implications are drawn.
TopIntroductory Argument And Current Outlook
Twenty years of Euro Era reveals some positive and negative facts. On the positive side one can mention Euro’s stability, ECB’s success in keeping inflation at low levels, that is, maintaining price stability (monetary discipline) and sustaining the strong global currency position in time. Monetary discipline in the union level mainly resulted from the existence and the use of the Common Monetary Policy. i.e. compulsory rules, time consistent, credible joint decision mechanisms to get and sustain monetary discipline.
In this respect, current outlook of the EMU reveals following strengths and opportunities:
- •
Maintenance of the price stability thanks to the Common Monetary Policy (ie. monetary policy coordination and joint policy decision mechanism in the Euro Area) (thus, inflation rates are low and close to each other). See Figure 1.
- •
Properly working Single Market.
- •
Existence of trade openness, trade partnerships and export diversification among members; implying the competitive advantage in global competition.
- •
Elimination of exchange rate uncertainty (Single Currency /Euro), and low transaction costs; being the second most used currency around the world.
- •
Awareness of the shortcomings of today’s incomplete EMU and existence of a formal initiative to complete the EMU. Europe discusses its future.
- •
The Eurozone, has become stronger and more stable power in the world economy in last twenty years.
Figure 1. Inflation, end of period, 2000-2018 (in %)
On the negative side, however, global economic/ financial crisis and the European debts produced fiscal instability and debt insolvency. Thus, fiscal/budgetary discipline has not been achieved in the union level due to the absence of a supranational mechanism such as Common Fiscal Policy, which means absence of compulsory fiscal rules, time consistent policies, and joint decision mechanism on the fiscal/budgetary side. This leaves the EU with the problem of unsustained debts and fiscal unsustainability.
A monetary union can be very fragile and governments of member countries face serious adjustment problems when especially hit by large permanent asymmetric shocks since asymmetric demand shocks lead to increasing budget deficits and liquidity crises via fragile financial markets facing very high interest rates and reduced economic activity. This may force the government to introduce fiscal austerity measures, such as increasing taxes reducing spending and thereby worsen the recession. In this case, wage flexibility and labor mobility are necessary to correct for these asymmetric shocks, that is so called “automatic adjustment mechanism” which works as an insurance mechanism. However, the adjustment for wage and labor mobility is proved to be costly and painful in times of financial crises and recession (de Grauwe, 2017: 17-19).
That is, current outlook of the EMU also reveals following weaknesses and threats (See Figure and Table in the Appendix):