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The Eurozone Crisis: the fire is out, what next?

13 May 2010

The previous weekend which marked the 60th anniversary of the Schuman Declaration on 9 May, was one of the busiest in the EU’s history. After 11 hours of discussions on Sunday, the EU’s finance ministers agreed on the €500bn emergency fund (plus another €250bn from the International Monetary Fund), not only to help Greece but to prevent  further attacks on other heavily indebted eurozone countries such as Portugal, Spain and Ireland.

The agreed fund is a mix of loans and loan guarantees, which would fit under the existing fund for non-eurozone countries, known as the balance of payments assistance facility, which will be extended to eurozone countries. The financial markets have responded positively to this decision, and it seems that the eurozone leaders have managed to stop the contagion in the eurozone, at least for now.

However, to seriously address the systemic problems of the Eurozone, it is time for the European Union to reconsider the whole structure of the Economic and Monetary Union. The European Commission has come forward with the Communication “Reinforcing economic policy coordination”, where it proposes that the eurozone countries should review each others’ draft budgets in the first half of each year (called “European Semester”) before they are adopted by national parliaments. The idea is to achieve a closer economic surveillance, because it was the “chronic failure” of the countries to comply with the Stability and Growth Pact, a commitment EU leaders made in 1997 to aim for balanced budgets, which led to the current crisis.

On the one hand, the Commission proposes punitive measures for countries that infringe the EU’s existing rules, like cutting regional aid and imposing interest-bearing deposits.  On the other hand, countries which accumulate large surpluses during periods of economic prosperity would be allowed to spend more during downturns without being subjected to an excessive deficit procedure. The Communication also addresses the issue of macroeconomic imbalances (thus touching upon the politically sensitive issue of big trade surplus of Germany and its negative impact on the competitiveness in other countries), saying that assessments of national economic reform programmes would be synchronised with budget discipline reviews. A regularly monitored scoreboard would review macro-economic indicators such as, among others, developments in current accounts, productivity, unit labour costs, employment, and private sector credit in order to detect asset price booms and excessive credit growth at an early stage. The proposed system would imply “deeper surveillance, more demanding policy co-ordination and stronger follow-up”. As part of the reforms, the Commission aims to create a permanent crisis-resolution mechanism in the eurozone that would replace the temporary facility agreed this weekend.

As bold as they are, these proposals could still be watered-down by member states. It is difficult to predict at the current stage what new rules would be adopted and how strongly they would be enforced. Previously, EU Member States have reserved the final authority over taxation and spending for their national parliaments, and there are already signs of resistance in various eurozone countries, especially in Germany and France. However, as it was stressed by José Manuel Barroso, President of the European Commission: “You can’t have a monetary union without having an economic union. Member States should have the courage to say whether they want an economic union or not. And if they don’t, it’s better to forget monetary union all together.” The ideas put forward by the Commission are now up for discussion by eurozone finance ministers next week. The heads of state and government will have their next summit on 17-18 June.

In the meantime, the heavily indebted eurozone countries will have to reinforce their efforts to solve their fiscal problems. Portugal has already postponed big investments projects like its new airport, and Spain has announced further spending cuts. However, the strict austerity measures in Greece have already caused violent protests and the recent polls are showing declining trust in Prime Minister George Papandreou’s handling of the economy. Moreover, the underlying concern is that the huge budget cuts might have adverse effects, plunging the economies into a deeper recession thus prolonging the debt crisis. The €500bn rescue fund may have calmed the financial markets for a while, but the eurozone is still facing difficult times ahead.

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