Benoît Coeuré: The euro area's three lines of defence
Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank, at
the conference "Deepening of EMU", Ljubljana, 2 February 2018.
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For a long time, the European Central Bank has been at the forefront of macroeconomic
stabilisation in the euro area. There's broad agreement that without our unprecedented actions,
the euro area would have fared far worse. Even more people would have lost their jobs, and
wages and prices would have stagnated for much longer, or would even have fallen. Although our
actions were bold and unparalleled, we acted within our mandate, as confirmed by the European
Court of Justice.
The establishment of the European Stability Mechanism, and the progress made in setting up a
banking union, have fixed some of the shortcomings in euro area governance and instruments.
These steps were important in easing the pressure the crisis has put on the ECB. But many of
the institutional failings that caused and perpetuated the crisis remain unresolved. Incentives to
pursue sound policies remain too weak and stabilisation of shocks too difficult. These are
deeprooted issues that cannot be resolved by a few years of above-trend growth. To assume that the
current economic expansion will heal all wounds is naive. The euro area needs reform.
As the central bank of the euro area, the ECB should not interfere in the details of what is mostly
a political debate. But we have a stake in the success of the current discussion. Without further
reforms, the next crisis may well force the ECB to test the limits of its mandate. Depending on
the nature of the next crisis, policy action might require taking short-term rates much deeper into
negative territory. Or it might require purchases of assets that are riskier than public or corporate
debt. Or it may draw us dangerously close to monetary financing of governments.
As things stand today, and given member states' still limited fiscal policy space, even a small
downturn could create large economic and social costs. It could, once again, test the
cohesiveness of the currency union. Unless the euro area finds a way to change direction, to
reform itself and to regain space for active macroeconomic policy, the same fractures we saw in
2012 could reappear and widen when the next downturn comes.
Many ideas for reforms are being floated, of course. Some are bolder than others. The recent
proposals by German and French economists are a worthwhile attempt to bridge differences and
surmount trade-offs. Today I will not offer another blueprint. What I will offer instead are
requirements than any euro area reform will have to pass. I will call them the three "lines of
defence" that any well-functioning monetary union depends on. They are needed to deliver a
stable currency. They are needed to protect the ECB and its mandate. And they are needed to
keep belief in the future of the euro strong.
Flexible markets form the first line of defence.
They are indispensable for a currency union. They reduce the need for macroeconomic
stabilisation and curb contentious debates about crisis management. Markets that can absorb
shocks efficiently do not waste costly political capital. And they create more policy space in
downturns, for both fiscal and monetary policy.
To bolster the first line, the way we implement economic policies needs to change. The current
system has clearly not delivered its intended benefits. Take the European Commission's
country-specific recommendations as an example. In 2016, less than 5% of the
recommendations were implemented by Member States. Limited enforcement of the
recommendations, rather than the incorrect identification of the main issues, has made the
existing framework fail.
Why? Because recommendations from outside a country, even if correct on substance, are
typically dismissed. Sovereign governments don't accept what they see as diktats from
Brussels. Economists should have known better. Incentives are the drivers of our actions. So, if
outside recommendations are perceived as being politically too costly, then we need to find
solutions that promote national "ownership" of reform efforts. Money is not the answer. It is
political incentives that need resolve.
The other key domain to spur the catalyst function of our market economies is the Single Market.
It is incomplete as we all know. Take services as an example. They account for over 70% of the
EU's GDP and an equal share of its employment. But we still face significant barriers when it
comes to cross-border service provision in the EU. The Services Package that was adopted
about a year ago was a step in the right direction but more needs to be done.
Efficient and integrated financial markets are part of the first line of defence. In the United States,
around 60% of a shock to a state's GDP is cushioned by financial markets. In the euro area, the
share is currently closer to 20%. Country-specific shocks remain unsmoothed to a large extent,
mainly because cross-border equity risk-sharing is hugely underdeveloped in Europe.
A true capital markets union could significantly help to diversify and reduce risk. It would thereby
limit the financial burden to be levied by governments in the case of adverse shocks. And it would
broaden the scope of monetary policy transmission beyond the banking sector, making policy
less vulnerable.
Finally, to avert banking collapses, governments in the past were forced to disburse large sums
of public money in the pursuit of economic and financial stability. Completing banking union will
reduce risks for taxpayers and break the remaining link between banks and national
governments. A European deposit insurance scheme is a precondition for a truly integrated
banking system and single money. Let us not forget that 86% of our money is created by
commercial banks. The transmission of the ECB's monetary policy will always be incomplete as
long as differences in depositor confidence prevail across the euro area.
The second line of defence relates to the role of governments.
Even the most flexible and efficient markets cannot fully absorb very large shocks without
imposing economic hardship on a considerable number of people. In other words, flexible
markets come at a price. They increase uncertainty for employees and often require
relinquishment.
Uncertainty, for example, is born of the fear of a loss of employment or of not being able to
respond to today's fast pace of change. But it is also born of the fear that governments
themselves have been pushed to the sidelines as globalisation has proceeded. Recent election
outcomes around the world bear witness to this fear. The more exposed individuals are, the
more likely a political backlash.
Governments can mitigate these effects. Unlike the United States, however, the European Union
is not a federation. This means that, as a rule, stabilisation and the provision of security in the
form of social services takes place first at national level. Keeping governments solvent is a
precondition for achieving that. As we saw during the crisis, if perceptions of sustainability among
markets decline, then counter-cyclical spending can quickly become constrained. So we need to
regain fiscal space, which means building adequate national fiscal buffers.
The current broad-based economic expansion is contributing a lot to this end. But many
countries are emerging from the crisis still bearing legacy burdens that could take decades to
resolve. This leaves us vulnerable to divergence and fragmentation when a crisis strikes - and in
some ways, even more so than before.
Fiscal consolidation therefore needs to go hand in hand with efforts strengthening our area-wide
defences. Of course, the ESM is already an important safeguard. But we need to enhance its
competences in the field of crisis management and make it more agile. This includes making full
use of its existing instruments, such as the direct bank recapitalisation tool and precautionary
financial assistance, and moving away from the unanimity requirement. And in the long run, it
means bringing the ESM into the community framework. The stability of the euro area cannot be
in the hands of one, or a few, Member States and their parliaments. Ultimately, the ESM needs to
be accountable to the people of Europe.
But union stabilisation cannot stop with the ESM. The euro area needs a fiscal instrument that
can help it cope with large shocks without having to rely excessively on the ECB.
Such an instrument would be the third line of defence of our monetary union.
It would support aggregate demand in countries experiencing a crisis, drawing on common
funds. It would thereby provide an additional layer of stabilisation that safeguards trust in national
policies. EU solidarity would then take on a whole new meaning.
Whether such an instrument would directly support national safety nets, or would instead
undertake investment projects that create jobs and income, will be subject to much debate.
Whether it should be balanced by stronger market discipline will be even more heatedly debated.
These discussions will take time. However important, they should not obscure what should be
governments' urgent priority: strengthening the first two lines of defence of our monetary union.
Achieving lasting economic stability must involve finding a balance of discipline and flexibility in
our economies. This will both strengthen support for the euro and help alleviate the pressure and
burden on the ECB in crisis times.
Realpolitik will dictate the speed of reforms. What we do need is broad agreement that they will
be built on these three lines of defence, and visible progress on the first two.
Thank you.