Fabio Panetta: Deepening and widening Economic and Monetary
Union - finding the right speed
Introductory remarks by Mr Fabio Panetta, Member of the Executive Board of the European
Central Bank, at the European Parliamentary Week, Brussels, 18 February 2020.
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It is an honour for me to speak here today. Economic and Monetary Union (EMU) calls for
European and national policies to work in sync, which in turn requires close cooperation between
European institutions and you - European and national parliamentarians.
From the start, the EMU project has been accompanied by two central debates. The first relates
to the order of integration, with some arguing that political convergence should come before
monetary union and others reasoning that economic integration would spur political integration.
And the second relates to the question of whether to already incorporate new members into the
euro area or first deepen its institutional underpinnings.
These debates highlight choices that go beyond economic considerations. They reflect Europe's
common will to grow closer together over time. That political commitment has proven to be
stronger than many believed.
But if this commitment is to endure, it will need to be supported by effective policies. I see two
priorities here. First, as the euro area widens, the need to make the architecture of EMU fit for
purpose becomes increasingly urgent. Second, in the interests of both new and existing euro
area members, we need to collectively ensure that accession is fully prepared. This will avoid
EMU being deepened too slowly or widened too fast.
Harnessing the benefits of economic integration
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The case for European economic integration remains as strong as ever, if not stronger. On their
own, European economies are too small to withstand spillovers from large economic regions, to
leverage power in international trade negotiations or to enjoy a sizeable international role for their
currency. Cooperating at the European level and sharing a currency increases their influence in
the world.
Take the euro itself. It represents a political bond but also acts as a source of economic
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strength. As the world's second most-used currency, the euro allows countries to invoice trade
in their own currency, reducing the pass-through of exchange rate volatility to import prices and
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thus to inflation. Membership of the euro area gives countries a genuine voice in setting a shared
monetary policy rather than de facto accepting a policy set elsewhere.
But economic integration needs to be managed effectively if we are to reap its full benefits. As
more countries join the euro area, its economic structure becomes more diverse and the
potential for spillovers between countries and financial structures grows larger. If insufficiently
managed, this interconnectedness can exacerbate business cycle misalignments between
countries, thus reducing the traction of the single monetary policy.
During the crisis, this theoretical observation became viscerally real. The incomplete nature of
EMU led to a debt crisis-related recession in 2012-13, which was unique to the euro area
economy. It complicated the monetary policy process and contributed to the need for specific,
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non-standard, monetary policy instruments to address fragmentation.
The ECB rose to this challenge and fulfilled its mandate, stabilising inflation in the euro area. In
the process, it supported economic growth and job creation: Since the start of its recovery in
2013, the euro area economy has created over 11 million jobs. And according to some
estimates, about one third of the 5-percentage-point increase in the employment rate observed in
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the euro area as a whole since mid-2014 is due to the ECB's measures
. Significant steps were also taken to make the EMU architecture more resilient, by creating joint
banking supervision, a common system to deal with failing banks and the European Stability
Mechanism to help countries in need.
But, as we can see from recent developments, more needs to be done. Inflation is still below the
Governing Council's aim, and while growth is showing signs of stabilisation, it remains modest.
Against this background, the euro area economy will continue to require support from our
monetary policy for as long as necessary to ensure the robust convergence of inflation to our
aim. The incomplete nature of EMU is a part of this story. Monetary policy has been insufficiently
flanked by support from fiscal and other policies. This, in turn, has conceivably led to lower
growth and inflation than would otherwise have been the case.
Accelerating the deepening of Economic and Monetary Union
Critically, risk-sharing between countries remains lower in the euro area than in other economic
regions. It is estimated that, since the start of EMU, around 80% of a country-specific shock to
GDP growth has remained unsmoothed in the euro area, thus amplifying fluctuations in citizens'
consumption, which, ultimately, worsens their welfare. By contrast, in the United States, less
than 40% of a shock to state-specific GDP was not smoothed over the same period. In the
United States, smoothing is mainly undertaken by private investors and companies who, by
diversifying their holdings across states, can mitigate recessionary pressures in their own state
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through financial income from other jurisdictions not hit by negative shocks.
The crisis has once again reminded us of a fundamental lesson: as the euro area is set to widen,
it must strengthen its institutional structure. The most urgent task we face is to complete both
banking union and capital markets union, thereby increasing cross-border ownership of assets
and bringing about a more balanced financial structure.
The diversity of the euro area would then become a source of strength rather than weakness, as
financial holdings would be diversified across a wider set of countries and assets. Moreover, the
market would then cushion economic shocks, reducing the need for public money.
But more integrated financial markets, on their own, are not enough. A monetary union as diverse
as the euro area also needs a common fiscal instrument to maintain convergence when firms
and households collectively retreat across the union.
As the euro area widens and the preferences of its members become more varied, it may
become more challenging to find agreement on such projects. This is due less to
insurmountable differences - indeed, cultural diversity across the EU is estimated to be of a
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similar magnitude to that in the United States despite of the unifying role of language unity in the
latter country - than to divisions in decision-making. This reinforces the case for building strong
institutions with a clear mandate and full democratic backing, particularly as the euro area
widens.
An agenda for widening the euro area should thus be accompanied by an agenda for deepening,
and the two should be treated together in policy discussions.
Ensuring that euro area accession is beneficial to all
A deeper EMU, however, does not absolve countries from their responsibilities. Experience
shows that adopting the single currency can give rise to significant opportunities. But
opportunities are there to be used or to be wasted. History provides examples of both. Ensuring
that new euro area countries meet the economic and legal conditions for successful
membership therefore remains indispensable and, critically, is in everyone's interest.
And while it is important, of course, that countries adopt the EU's body of law before joining the
EU and fulfil the numerical convergence criteria before adopting the euro, these steps are not in
themselves sufficient to benefit from membership of the EU and the euro area on a lasting basis.
Relentless efforts must be made over time to implement countercyclical fiscal and
macroprudential measures, proper debt management, sound banking supervision and
growthenhancing structural policies. There will be neither resilience nor convergence unless national
and EU authorities give the utmost priority to enhancing their institutions and governance. In the
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words of the EU Treaties, we need "sustained convergence".
It is in the interest of all Member States to avoid time inconsistency, that is frontloading the
economic benefits of joining the euro area whilst incurring the cost of insufficient convergence at
a later stage. The launch of monetary union was accompanied by a pronounced convergence of
long-term interest rates, but many countries failed to use the resulting boost to public and private
finances to address existing imbalances or increase productive investment.
Many of the countries that joined later have performed more positively. This was true of the Baltic
States, for example, and also of Slovakia, which, since adopting the euro, has seen its GDP
grow each year by around 0.9 percentage points more than its immediate neighbour, the Czech
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Republic. This shows that it is possible to capitalise on the higher trade and investment that
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come with joining the euro area.
And the process of adopting the euro has itself evolved. In particular, any country that wishes to
join the euro area must now be sufficiently ready not only for the single currency, but also for the
banking union. A prospective member has to request close cooperation between its national
banking supervisor and the ECB, meaning that its banking sector undergoes a comprehensive
assessment, potential weaknesses are addressed and the banking sector is supervised by the
ECB. This aims to mitigate the risk, to the extent possible, of banks failing in the future, thereby
weakening the economy and the public finances of one country with negative spillovers across
the entire euro area.
The question of whether to expand the euro area is and should remain a political decision to be
taken by citizens and their elected representatives. At the same time, the economic and legal
conditions for successful participation require careful scrutiny in the interest of all parties.
Conclusion
Let me conclude. Rather than arguing about whether it is more important to widen or to deepen
the union, I have made the case today that any expansion of the euro area must be accompanied
by measures to deepen it, both politically and economically.
Deepening EMU also hinges on the ambition of national governments in the Council. We have
the concepts for how to deepen the union, but we also need the political will to implement
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them.
Parliaments have a critical role to play. The European Parliament and national parliaments can
drive forward legislative integration. They can look out for spillovers from national policies to the
rest of the euro area. And they can hold European actors and national governments accountable
for their action - or inaction - on EMU.
Thank you for your attention.
See also Draghi, M. (2018), "Economic and Monetary Union: past and present", speech at the
EuropaKonferenz, Berlin.
2
Bergbauer, S., Hernborg, N., Jamet, J.-F. and Persson, E. (2020), "The reputation of the euro and the European
Central Bank: interlinked or disconnected?", Journal of European Public Policy, January.
3
See ECB (2019), The international role of the euro.
4
See Devereux, M. and Yetman, J. (2014), "Globalisation, pass-through and the optimal policy response to
exchange rates", Journal of International Money and Finance, 49(PA), pp. 104-128. See also Gopinath, G.,
Itskhoki, O. and Rigobon, R. (2010), "Currency Choice and Exchange Rate Pass-Through", American Economic
Review, Vol. 100, No 1, pp. 304-336.
5
See Blattner, T. et al. (2018), "Monetary policy and cross-border interbank market fragmentation: lessons from
the crisis", Working Paper Series, ECB.
6
Hartmann, P., & Smets, F. (2018), "The European Central Bank's Monetary Policy during Its First 20 Years",
Brookings Papers on Economic Activity 2018(2), 1-146.
7
See Cimadomo, J. et al. (2018), "Risk-sharing in the euro area", Economic Bulletin, ECB. See also ECB (2018),
Financial integration in Europe.
8
See Alesina, A. et al. (2017), "Is Europe an optimal political area?".
9
See Article 121(3) of the Treaty on the Functioning of the European Union.
10
See Nielsen, E. F. (2016), Research Note on Slovakia vs the Czech Republic, Unicredit Group, mimeo. See
also Havlat, M. et al. (2018), "Economic Convergence in the Czech Republic and Slovakia", Economic Brief, Vol.
34, European Commission.
11
See Havlat, M. et al. (2018), "Economic Convergence in the Czech Republic and Slovakia", Economic Brief, Vol.
34, European Commission.
12
Juncker, J.-C. et al., (2015), Five Presidents Report.