these policy failures were also made possible by a general failure to acknowledge the new governance responsibilities associated with membership of emu. put simply, “ keeping your own house in order ” is necessary, but not sufficient, in a highly integrated monetary union. it is the responsibility of every euro area government to exercise vigorous and effective mutual surveillance over others ’ policies. as a crisis in a country like greece representing only 2 % of euro area gdp can become systemic, disregarding emu governance may come at a high cost to taxpayers. yet the latter was the attitude prevailing prior to the crisis. the stability and growth pact – the set of eu level rules for guiding fiscal policies – was never properly implemented. member states tended to adopt a principle of “ non - interference ” over each others ’ policies. peer pressure, on which the framework was predicated, gave way to peer support. by watering - down of sgp in 2004 – 05, the largest euro area countries signalled that they had no stake in the rules. this allowed a certain country to run deficits over 3 % of gdp every year it was in emu and never face corrective action. moreover, the euro area surveillance framework was “ blind in one eye ”, with no formal framework for monitoring macroeconomic and financial imbalances. the lisbon strategy focused on the structural level, but on policy implementation rather than imbalances. eurogroup discussions on imbalances had no enforcement mechanism. the lamfalussy framework for financial supervision did not use the concept of systemic risk. thus a situation prevailed where countries could be congratulated for strong headline fiscal numbers when these data in fact reflected substantial imbalances that were building up in the private sector. to a certain extent, the weakness of these governance procedures was linked to a misplaced faith in market discipline. the institutional design of emu gave market discipline a central role in economic governance. the absence of a transfer mechanism between member states was supposed to encourage markets to actively discriminate between euro area issuers. this was based on the assumption that financial markets would always have perfect incentives to enforce the “ rules of the game ”. this assumption, in retrospect, looks somewhat naive. it is well established in the academic literature that markets have complex incentives and dynamics. market psychology tends towards pro - cyclicality. perceptions converge around certain information sources, such as ratings, or certain benchmarks, such as indices, which creates herd behaviour. structural features of the financial system, such

of existing efsf resources in order to increase the fund ’ s ability to act. but perhaps the most significant development, relative to past expectations, is the implementation of root - and - branch reform programmes in a number of euro area countries. bis central bankers ’ speeches one should not underestimate the significance of eu - imf programmes for structural changes in some economies. they are dealing with long - needed pension reforms, opening up closed sectors of the economy, modernising public administration. in terms of collective economic management, this development goes further than many federations. can we imagine, for example, the u. s. federal government requiring a similar depth of reform in california? countries outside of eu - imf programmes have also implemented major reforms. spain has recently passed a constitutional balanced budget amendment, disproving the view that major policy changes are impossible in an election year. italy has agreed to a technocratic government to ensure structural reforms are implemented, and invited the imf to give extra credibility to this process. all euro area countries, except those under a programme, have committed themselves to bringing their budget deficits below 3 % of gdp by 2013 at the latest. overall, the forward commitments of euro area countries to fiscal sustainability go far beyond what has been agreed in the u. s. or japan. each of these measures, seen individually, may not represent the “ shock - and - awe ” or “ big bazooka ” that some commentators and markets participants call for. but when seen collectively, they represent a comprehensive broadening and deepening of euro area economic governance. and relative to a reasonable benchmark – the status quo ante – they are very significant developments. it is also worth noting that many steps have been taken to strengthen the financial sector regulation and supervision. under the leadership of the g20, a remarkable amount of work has been done by the financial stability board ( fsb ) and the basel committee in a demanding timeframe. profound regulatory reforms need to be implemented to address the underlying deficiencies that have become apparent in our financial system. in general, europe is exceeding international benchmarks in implementing these reforms. the commission issued a proposal in july 2011 aimed at transposing the basel iii framework into eu law. by doing this, it is among the first to introduce the basel iii framework and is taking a leading role in delivering on the g20 commitments. in line with basel iii, the commission ’ s proposal ( so - called crd iv ) provides