CASE Reports The Economic and Monetary Union: Past, Present and Future Marek Dabrowski No. 497 (2019) This article is based on a policy contribution prepared for the Committee on Economic and Monetary Affairs of the European Parliament (ECON) as an input for the Monetary Dialogue of 28 January 2019 between ECON and the President of the ECB (http://www.europarl.europa.eu/committees/en/econ/monetary-dialogue.html). Copyright remains with the European Parliament at all times. “CASE Reports” is a continuation of “CASE Network Studies & Analyses” series. Keywords: European Union, Economic and Monetary Union, common currency area, monetary policy, fiscal policy JEL codes: E58, E62, E63, F33, F45, H62, H63 © CASE – Center for Social and Economic Research, Warsaw, 2019 DTP: Tandem Studio EAN: 9788371786808 Publisher: CASE – Center for Social and Economic Research al. Jana Pawła II 61, office 212, 01-031 Warsaw, Poland tel.: (+48) 22 206 29 00, fax: (+48) 22 206 29 01 e-mail: [email protected] http://www.case-researc.eu Contents List of Figures 4 List of Tables 5 List of Abbreviations 6 Author 7 Abstract 8 Executive Summary 9 1. Introduction 11 2. History of the common currency project and its implementation 13 2.1. Historical and theoretic background 13 2.2. From the Werner Report to the Maastricht Treaty (1969–1992) 15 2.3. Preparation phase (1993–1998) 16 2.4. The first decade (1999–2008) 17 2.5. The second decade (2009–2018) 19 3. EA performance in its first twenty years 22 3.1. Inflation, exchange rate and the share in global official reserves 22 3.2. GDP growth and unemployment 25 3.3. Fiscal performance 27 3.4. Public attitude to common currency 30 4. Looking ahead: how to reform the EMU? 33 4.1. Does a monetary union need a deeper fiscal and political union? 33 4.2. How to deepen a fiscal and political union? 34 4.3. Fiscal sustainability challenge 35 4.3.1. Importance of fiscal discipline 35 4.3.2. Market discipline vs. fiscal rules 35 4.3.3. Debt mutualization: the wrong sort of federalism 37 4.3.4. How to overhaul the EU fiscal discipline mechanism? 37 4.4. EMU enlargement 38 References 41 3 CASE Reports | No. 497 (2019) List of Figures Figure 1: Inflation, end of period, 2000–2023 (in %) 23 Figure 2: Exchange rate of EUR against USD, 1999–2018, in USD per 1 EUR 24 Figure 3: Currency composition of official exchange rate reserves, 2010–2018, in % of total allocated reserves 25 Figure 4: Annual change in GDP, constant prices, 2000–2018 (in %) 26 Figure 5: Unemployment rate, 2000–2018 (in % of total labour force) 26 Figure 6: Support for the EUR as a home country currency, 2002–2018, in % of total number of respondents in the EA 30 Figure 7: Support for the EUR as home country currency, 2017–2018, in % of total number of respondents in each EA country 31 Figure 8: Support for using the EUR in the EU, 2010–2018, in % of total number of respondents in the EA 32 4 CASE Reports | No. 497 (2019) List of Tables Table 1: General government net lending/borrowing, 1999–2018 (in % of GDP) 28 Table 2: General government gross debt, 1999–2018 (in % of GDP) 29 5 CASE Reports | No. 497 (2019) List of Abbreviations BLEU Belgium-Luxembourg Economic Union BU Banking Union EA Euro area ECB European Central Bank ECOFIN Economic and Financial Affairs Council ECU European unit of account EDIS European Deposit Insurance System EDF Excessive Deficit Procedure EEC European Economic Community EFSF European Financial Stability Facility ELA Emergency Liquidity Assistance EMCF European Monetary Cooperation Fund EMI European Monetary Institute EMS European Monetary System EMU Economic and Monetary Union ERM Exchange Rate Mechanism ESCB European System of Central Banks ESM European Stability Mechanism EU European Union GDP Gross Domestic Product GG general government IMF International Monetary Fund MIP Macroeconomic Imbalance Procedure MRO Main Refinancing Operations OCA optimum currency area SGP Stability and Growth Pact TEU Treaty on European Union TFEU Treaty on the Functioning of the European Union UK United Kingdom US United States (of America) USD United States dollar WWI World War I WWII World War II 6 Author Marek Dabrowski is a Co-founder and Fellow at CASE – Center for Social and Economic Research in Warsaw, Non-Resident Scholar at Bruegel, Brussels, and Professor of the Higher School of Econom- ics in Moscow. He was Chairman of the CASE Supervisory Council and President of its Management Board (1991–2011), Chairman of the Supervisory Board of CASE Ukraine in Kyiv (1999–2009 and 2013–2015), and Member of the Board of Trustees and Scientific Council of the E.T. Gaidar Institute for Economic Policy in Moscow (1996–2016). He also held the positions of First Deputy Minister of Finance of Poland (1989–1990), Member of Parliament (1991–1993), and Member of the Monetary Policy Council of the National Bank of Poland (1998–2004). Since the end of 1980s, he has been in- volved in policy advising and policy research in Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Egypt, Georgia, Iraq, Kazakhstan, Kyrgyzstan, Macedonia, Moldova, Mongolia, Montenegro, Poland, Romania, Russia, Saudi Arabia, Serbia, Syria, Turkmenistan, Ukraine, Uzbekistan, and Yemen, and in a number of international research projects related to monetary and fiscal policies, growth and poverty, currency crises, international financial architecture, perspectives of European integration, European Neighbourhood Policy, and the political economy of transition. He has also worked as a consultant on a number of EU, World Bank, IMF, UNDP, OECD, and USAID projects. He was a Fellow under the 2014–2015 Fellowship Initiative of the European Commission – Directorate General for Economic and Financial Affairs, the author of several academic and policy papers, and an editor of several book publications. 7 Abstract Twenty years of euro history confirms the euro’s stability and position as the second global currency. It also enjoys the support of majority of the euro area population and is seen as a good thing for the European Union. The European Central Bank has been successful in keeping inflation at a low level. However, the European debt and financial crisis in the 2010s created a need for deep institutional reform and this task remains unfinished. 8 Executive Summary • The road to the European currency took more than 20 years from the first memorandum of the European Commission on this topic in 1969 and the Werner Report in 1970, to signing the Maas- tricht Treaty in 1992. It took nearly 30 years until the euro was launched on 1 January 1999. This road was not easy. The collapse of the Bretton Woods system in 1971, two oil price shocks in the 1970s and the resulting stagflation delayed political approval of the project by more than a decade. Then the crisis of the European Monetary System in 1992–1993 complicated Stage 1 of the preparatory phase. • The first two decades of euro functioning confirmed its stability, its role as the second most impor- tant global currency, and the ability of the European Central Bank (ECB) to keep inflation low. The euro enjoys the support of the majority of the euro area population and is seen as a good thing for the European Union (EU). • In most of its first decade (1999–2008), the European economy enjoyed high growth and macro- economic and financial stability. This changed, however, in the second decade (2009–2018) when the global and European financial crises hit the European economy. The monetary response of the ECB was largely adequate – the euro area managed to resist deflationary pressure coming from a far-reaching financial disintermediation. However, countries which suffered from a sovereign debt or banking crisis (or both) had to resist market pressures on their exit from the euro area. Greece, which experienced the longest and most painful crisis, found itself on the verge of leaving the euro area in July 2015, which was eventually avoided by the third rescue package provided by the European Stability Mechanism (ESM). • All crisis-affected countries that lost market access received a conditional bailout provided by oth- er euro area countries and the International Monetary Fund, with the support of the ECB. This meant, however, circumventing a no-bailout clause in the Treaty on the Functioning of the Euro- pean Union. The content of rescue packages and how they were delivered remains a subject of political, economic and legal controversy until now. • The crisis experience triggered a series of institutional reforms in the EU and euro area. They in- cluded, among others, strengthening the Stability and Growth Pact (SGP) and adopting the Fiscal Compact, introducing national fiscal rules, launching the Macroeconomic Imbalance Procedure and European Semester, setting up the ESM and Banking Union (without the European Deposit Insurance System (EDIS), which is still a subject of political discussion). 9 CASE Reports | No. 497 (2019) • The reform of the euro area needs to continue. The reform agenda was elaborated in the Five Pres- idents Report in 2015. However, there is a lack of consensus with respect to several proposals, for example, the degree of further fiscal and political integration, debt mutualization, the euro area budget, financial instruments which could cushion asymmetric shocks, etc. • Given the high level of public debt in several euro area countries and the fiscal roots of most crisis episodes, strengthening fiscal discipline is the most important task. This can be done by restoring the no-bailout clause (market discipline) on the one hand and simplifying the SGP on the other. • The EU member states that remain outside the euro area should consider euro adoption in the not- so-distant future.