Euro 2.0: Past, Present, and Future of Euro Area Integration

IMF News, June 25, 2018

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• Published: June 25, 2018

Introduction / Context

• Remarks delivered by Christine Lagarde, IMF Managing Director, at “The Euro at 20 Conference” — Dublin, Ireland.
• Theme: assessing 20 years since creation of the euro, taking stock of achievements, crises, lessons learned, and policy priorities for a strengthened “euro 2.0.”

Looking back — 20 Years of the Euro (Findings)

• The common currency capped a 50-year quest to tear down economic borders.
• Today, 19 of 28 European Union members are part of the euro area, and the euro is the world’s second major reserve currency.
• In the European Union, real GDP per person has increased 40 percent since the mid-1990s. (Real GDP per capita measured in purchasing power parity terms.)
• In the run up to the adoption of the euro in 1999, strong convergence occurred in real income levels among the original euro area members; interest rates began to converge even before the common currency was introduced.
• In some cases these shifts contributed to excessive borrowing, unsustainable growth levels, and eventually, the euro area crisis.
• Several countries hit hardest during the global financial and euro area crises saw their income growth fall significantly behind that of their peers; many are only now recovering to pre-crisis levels.
• Ireland case study:
  • Joined the European Communities in 1973; founding member of the European Exchange Rate Mechanism in 1979; signed the Maastricht Treaty in 1992.
  • Up until the crisis, Ireland experienced the “Celtic Tiger” boom beginning in the early-1990s.
  • In real terms, average Irish income per capita more than doubled since signing of the Maastricht treaty.
  • Growing financial integration supported rapid expansion of credit and unsustainable real estate booms in countries such as Ireland and Spain; when boom turned to bust, Irish banks ran into serious trouble, placing Ireland at the heart of the euro area debt crisis.
  • After difficult choices, sacrifices, and support from European partners and the IMF, the Irish economy has rebounded strongly.

Taking Stock — The Current Moment (Actions and Institutional Reforms)

• Crisis-response institutions and actions:
  • The European Stability Mechanism and its predecessors worked with the IMF and provided over 250 billion euros in loans to the five countries hit hardest by the crisis.
  • The European Central Bank (ECB) signaled in 2012 its willingness to do “whatever it takes” to preserve the currency union.
  • Development of the Banking Union, including the Single Supervisory Mechanism and Single Resolution Mechanism, helped create a more unified banking sector.
• Lessons learned:
  • The cost of the banking crisis, including protection of banks’ wholesale creditors, was largely borne by taxpayers in some cases; the new bank recovery and resolution regime is designed to make banks safer and limit the risk that taxpayers will be asked to help bail out banks.

Looking Ahead — Euro 2.0 (Policy Recommendations)

• Christine Lagarde identifies three major areas for enhancing resilience and securing the euro area’s future:

1. Complete the Banking Union

• Establish an adequate backstop for a Single Resolution Fund.
• Implement a common deposit insurance scheme.
• Rationale: insuring credit risks across member countries can weaken the “sovereign-bank doom loop.”

2. Integrate financial and capital markets

• Ensure regulatory and supervisory capacities are prepared for the influx of financial firms moving to continental Europe — and Ireland — as a result of Brexit.
• Over the medium-term, pursue greater harmonization of national insolvency regimes and securities regulations.
• Example: European Venture Capital Regulation facilitates cross-EU venture capital financing for start-ups.

3. Introduce greater fiscal risk-sharing while reducing underlying fiscal risks

• Avoid overreliance on monetary policy as in the last crisis.
• Greater risk-sharing combined with larger national buffers would allow countries to avoid raising taxes and cutting spending during downturns.
• The IMF proposed a central fiscal capacity described as “a rainy-day fund”; other proposals for a euro area fiscal capacity have been put forward.
• Emphasis: every country must comply with common fiscal rules and reduce public debt where it is too high.

• Complementary recommendation:
  • Continue structural reforms to address weaknesses holding back growth and to improve resilience and productivity.

Framing and Urgency

• Current macro conditions described as “solid growth and steadily declining unemployment across the euro area” make this the time to act.
• Quoted adages highlighting urgency:
  • Maria Edgeworth: “If we take care of the moments, the years will take care of themselves.”
  • John Fitzgerald Kennedy: “The time to repair the roof is when the sun is shining.”
  • Bono: “It is stasis that kills you off, not ambition.”
  • W. B. Yeats: “In dreams begins responsibility.”

Conclusion

• Securing the euro area for the next twenty years requires patience, creative thinking, and increased cooperation.
• The objective: a euro area that is not merely a union of convenience in calm waters but “a strong shield amidst storms.”
• Call to action for scholars and policymakers to identify problems and make progress toward solutions, with the IMF as a partner in the effort.

Opening Remarks by Christine Lagarde, “The Euro at 20 Conference” — Dublin, Ireland, June 25, 2018.

References

• Christine Lagarde
• Ireland and the IMF
• Speeches
• PRESS CENTER
• The IMF recently introduced our own proposal
• https://www.imf.org/en/home