Benoît Coeuré: Towards a consistent, coherent and complete Economic
and Monetary Union
Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank,
at the conference "Financial stability and the Single Market - the keys to growth in Europe"
on the occasion of the 20th anniversary of the Single Market, organised by the European
Commission, Brussels, 19 November 2012.
* * *
I wish to thank Wouter Coussens for his contribution to this speech. I remain solely responsible for the opinions
contained herein.
Introduction
Commissioner Barnier, Ladies and Gentlemen,
I would like to thank the European Commission for inviting me to speak at this conference on
"Financial Stability and the Single Market".
The crisis has demonstrated the incomplete character of Economic and Monetary Union.
Much thought has already been given to diagnosing the issues, identifying the shortcomings
of our current institutional set-up and outlining possible solutions. Further food for thought will
no doubt be offered throughout the day in this room. But the time that lies ahead is the time
to take decisions.
Since the publication in June of the first draft of the "Four Presidents' Report" on the future of
EMU, the commitment by the European Council to the banking union, the ECB's decision on
Outright Monetary Transactions, and also thanks to visible adjustment efforts in euro area
countries, there has been a return of confidence in the outlook for the euro area. Both the
status quo and a piecemeal approach to EMU reform would weaken the assumptions
underlying this return of confidence.
Today, therefore, I wish to make a plea for consistency, coherence and completeness in the
institutional reforms we are seeking. And I will do so by elaborating on each of the building
blocks identified by the four Presidents in June.
What I will do for each of these building blocks is to highlight in what respect EMU is
incomplete, why it matters, and how the situation can, in my view, at least be remedied. In
doing so, I hope it will become clear to you how these four building blocks form a consistent
whole.
Why the euro needs a banking union
Let me begin with the so-called financial or banking union. The heart of the problem here is
the fragmentation of the euro area banking system. I will not dwell on the symptoms of
fragmentation. They are well known and have been documented, e.g. in the ECB's reports
on Financial Integration in Europe and Financial Stability Reviews, and have covered, among
other matters, the renationalisation of interbank markets, dispersion of bank funding costs
and bank lending rates along national lines.
Equally well documented is the high correlation between the creditworthiness of banks, as
well as their funding conditions, and the creditworthiness of their respective government. The
ultimate protection of senior bank creditors, depositors in particular, comes from the fiscal
backstop provided - or not - by the sovereign. It is therefore not surprising that the
fragmentation of the banking system along national lines only became visible and damaging
after the start of the sovereign debt crisis, even though the fault lines had existed beneath
the surface.
The fundamental reason why this matters is that the single currency is really single only if the
banking system is also single. Money, remember, is the liability of the banking system. Base
money, issued by the Eurosystem, is undoubtedly single, but it represents only a fraction of
broad money. The remainder is issued by commercial banks. If the credit of the banking
system - including deposits - is fragmented along national lines, then so is money.
More prosaically, if there is a national bias in the funding cost of banks, then monetary policy
impulses cannot be transmitted uniformly across the euro area.
So how can the singleness of the banking system be ensured?
The first option would be to strengthen the creditworthiness of individual sovereigns so that
differences between them became negligible. It would mean moving to the situation, not as it
was, but as it should have been, and was perceived to be before the crisis. Under this
approach, national governments would remain responsible for backstopping their banking
system, but this backstop would be robust across the euro area.
This is appealing, but it has two shortcomings.
First, current conditions are not favourable. Most governments have excessive levels of
public debt and will need several years to restore their creditworthiness to the point where all
could be deemed equally robust. In the meantime, bank access to funding would remain
fragmented along national lines. This would perpetuate divergences in the conditions of
access to credit for firms and households, and jeopardise national adjustment efforts. The
potential for negative feedback loops or "multiple equilibriums", to use the economic jargon,
is obvious. National economies would continue to diverge.
The second shortcoming is that this approach assumes that market discipline is totally
effective. The "keeping the house in order" approach functions if markets are correctly
differentiating. I am a firm believer in the usefulness of market signals. Note, for instance,
that the Outright Monetary Transactions will leave ample room for market forces to play: at
the short end of government yield curves in normal times, and at the long end at all times.
But we know from what happened before and during the crisis that we cannot always rely on
market signals.
The alternative is that the banking system is backstopped at the European level. In other
terms, the link between national banking systems and their sovereign is severed and
replaced by a relationship between the euro area banking system as a whole and European
institutions. In that case, we would truly have a single banking system.
Here again, several options can be envisaged, but the key is completeness and consistency.
What it means, in my view, is the following.
A genuine banking union is one where the location of deposits does not play a role in the
confidence they inspire. This will require three interconnected elements: first, a strong, single
supervisory mechanism to prevent crises; second, a common resolution scheme which
allows effective and early decisions to be taken if a crisis nonetheless occurs; and third,
eventually, a common European backstop which can be called upon in the event that there is
still a need for public resources despite the involvement of the private sector. These three
elements are complementary and mutually reinforcing.
Since work on the SSM has advanced the most, and since it involves the ECB as host, let
me make a few observations in this regard.
First, it is crucial that all banks are covered by the SSM. A two-tier system would result in an
uneven playing field, effectively segmenting the banking sector, which is precisely what we
are trying to repair. Putting all banks under the umbrella of the SSM does not mean that
supervision would be conducted entirely from Frankfurt. That would be neither effective nor
desirable. We should - and would - rely on the resources and knowledge of the national
supervisors.
A second point is that arrangements need to be made to separate financial supervision from
the ECB's monetary policy function. We are examining procedures that would separate
clearly the relevant workstreams supporting the two functions, and strictly limit Governing
Council involvement in supervisory matters.
Yet separation should not mean isolation. There are important synergies to be achieved
between the two functions, an argument that is gaining international recognition and that the
Eurosystem made publicly as early as 2001.1 Most euro area governors are already banking
supervisors. Supervision could allow for better-informed monetary policy-making. In parallel,
monetary policy operations could provide useful signals to the supervisory function, for
instance, when a bank relies disproportionately on central bank funding. The creation of the
SSM is an opportunity for Europe to rethink the links between banking supervision and
monetary policy in a way that can strengthen both functions and learn the lessons of past
banking crises, such as avoiding "zombie banks" infused with central bank money or the
evergreening of non-performing loans.
The SSM does not need to be limited to the euro area. As the cornerstone of a financial
market union, it is necessary for the euro area, but it is desirable for the EU as a whole. The
participation of additional Member States is welcome and would strengthen the Single
Market. These countries have raised legitimate concerns about a fair involvement in the
decision-making of the SSM. We are working hard on arrangements that would address
those concerns consistent with article 127.6 TFEU.
Two versions of the fiscal union
There exists a link between the notion of a banking union and the second topic highlighted by
the four Presidents in June, that is the fiscal union. A fully-fledged banking union, including
resolution and deposit insurance, assumes a partial fiscal union. Let me note that this does
not imply that the structure and powers of the SSM can only be decided upon when we know
the full details of the fiscal union. The SSM as such does not have fiscal consequences, and
should be implemented promptly.
What I am referring to here is a first interpretation of the fiscal union: a limited risk-sharing
capacity allowing the absorption of idiosyncratic shocks. These shocks cannot entirely be
absorbed by national policies alone, given the constraints imposed by the single monetary
policy and the lack of an exchange rate. Therefore, there has to be a euro area fiscal
capacity, as a form of limited rainy day insurance. Whether other tasks could be assigned to
this common fiscal capacity, such as supporting allocative efficiency, is a matter of choice,
not necessity.
Let me voice two words of caution. First, such risk-sharing capacity should serve as a
complement, not a substitute to fiscal responsibility at national level. It should not undermine
the implementation of the strong national fiscal governance rules enshrined in the Fiscal
Compact. Second, the fiscal union should be precisely delineated so that is does not mutate
into a transfer union. Transferring resources permanently from core to peripheral countries
would be tantamount to accepting that economies will not adjust and that countries will not
find their way back in the global economy.
This brings me to a second possible interpretation of fiscal union, which refers to a transfer of
fiscal governance from the national to the European level, in the form of enforceable control
of national budgets.
I would argue that such a transfer of governance would not amount to a loss of sovereignty
recovering
but to sovereignty. Let me explain. To be able to borrow in a recession - and
crucially to be able to do so at affordable rates - governments rely on confidence among
investors that their fiscal position is sustainable. When this confidence is eroded, government
debt no longer acts as a safe haven. The cost of raising finance goes up and this can set
adverse debt dynamics in motion. In extreme circumstances, governments can lose access
to markets, which has happened in several euro area countries. From this perspective, the
sovereign debt crisis in the euro area is tantamount to a loss of fiscal sovereignty.
With respect to the establishment of a fiscal union that fully supports the return of the euro
area to full viability, we ought therefore to distinguish between fiscal rules which underpin
sustainability, and rules of enforcement which underpin credibility.
Fiscal rules, as they have now been designed, agreed, and enshrined, in particular in the
six-pack and two-pack legislation as well as the Fiscal Compact, are an important step
forward. These rules are designed by reference to structural deficits, thereby assigning clear
and realistic medium-term objectives, while allowing for the absorption of cyclical shocks.
Where credibility can still be improved, however, is at the level of enforcement. A number of
ideas have been put forward in this context, including that of endowing a European
Commissioner with the power to intervene in national budgets.2 Each of these options raises
its own set of issues, not least the clear-cut need for strong political legitimacy of any form of
control.
Which of these two interpretations of the fiscal union should eventually prevail? I would say
both. Europe is a unique construct that needs to find its own balance between the roles of
the euro area and national fiscal responsibilities.
Economic union
The genuine completion of banking and fiscal unions would ensure that the union and its
members are better able than they are now to withstand a wide variety of shocks: cyclical
shocks, exogenous asymmetric shocks, as well as, if need be, shocks arising from the
banking system.
There exists, however, a final category of shocks to which monetary union must be
impervious. They derive from inadequate policies - labour market policies, for instance - or
the absence of corrective policies, which amounts to the same. If left unaddressed, this either
results in prolonged economic divergence - which is inconsistent with the objectives of the
Union, or in permanent fiscal transfers - which is politically unacceptable.
What is necessary here, at the very least, to complete monetary union?
First and foremost, in my view, is the completion of the single market in all its aspects. The
European Union is a market economy in which each country can benefit by exploiting its
comparative advantages. The euro was introduced to serve the single market and ensure its
viability. The argument is symmetric: the completion of the single market is necessary to
allow each country to effectively exploit its comparative advantages and to prevent the
imbalances that would otherwise undermine the viability of the euro. That is why the ECB
fully supports the Single Market Acts I and II.
Second, where macroeconomic imbalances occur as a consequence of inadequate policies,
those imbalances need to be identified early and corrective action taken. I believe that the
surveillance tools are now in place, in particular through the Macroeconomic Imbalance
Procedure, and that the emphasis should now be on implementation and enforcement by the
European Commission.
The interim report on the future of EMU in October suggested that euro area Member States
could enter into contracts with EU institutions, under which they would commit to undertake
specific structural reforms, on the basis of measurable and verifiable targets. Correctly
designed, those contracts could both enhance national ownership and reinforce - rather than
weaken - existing economic coordination procedures. There could be a role here for the euro
area fiscal capacity, which could provide financial incentives to countries partaking in those
contracts.
Political union
The last building block identified by the four Presidents in June is political union. In fact this is
not a separate building block - it cuts across the entire discussion on other points. Decisions
that have fiscal consequences require democratic backing. Any form of European control
over national policies must be based on political legitimacy and strict accountability, in
particular vis-à-vis the European Parliament. We at the ECB are very well aware of the need
for democratic accountability wherever power is delegated. The ECB's new supervisory task
must be matched by additional reporting and accountability channels.
Yet, I think the general issue here is one of clarification, rather than one of
institutionbuilding. The notion that the euro is a currency without a state is in my view misguided. The
euro is a currency with a state, only with a state whose branches of government are not yet
clearly defined. Here again, let me explain:
As I underlined earlier, the euro was created to serve the single market. That market itself is
a political construct. It not only presupposes the freedom to play a part in the market - that
would be anarchy. It also presupposes the means to protect that freedom, such as the
protection of property rights and the enforcement of contracts. For there to be a single
market, there must be a legislative body that establishes the rules and a judiciary that can
enforce them. If there is a legislative and a judiciary, there has to be an executive arm to
implement their decisions. For a market to function, the three branches of government have
to exist. This makes the single market a political union.
What is not yet entirely clear in the case of the euro area, and apart from the ECB which has
a clear but limited mandate, is who exactly will execute these powers, and to whom it will be
accountable. As we move towards a genuine EMU, this clarification will become ever more
necessary.
Conclusion
Mr Commissioner, Ladies and gentlemen,
There has always existed a debate as to whether the euro area is an optimum currency area.
I think this is a flawed debate, if by optimum we mean perfect, because no currency area is
ever perfect. The question we are facing is what the minimum conditions are to ensure the
full viability of the euro area over time.
As I said in my introduction, there has been increasing confidence in recent months that
these conditions will be met. Financial market participants have understood that there exists
a political commitment to the euro. Practical decisions are needed now to anchor this
confidence and commitment.
I will end my remarks by quoting - as is appropriate within these walls - from none other
qui est important, ce n'est, ni d'être optimiste, ni pessimiste, mais
than Jean Monnet: "Ce
d'être déterminé."
Thank you for your attention.