Can the Euro Area's Economic Governance be Reformed?
| Author | Phedon Nicolaides |
| DOI | http://doi.org/10.1111/1758-5899.12125 |
| Published date | 01 May 2014 |
| Date | 01 May 2014 |
Can the Euro Area’s Economic Governance
be Reformed?
Phedon Nicolaides
European Economics Department, College of Europe, Bruges
Professor Stefan Collignon concludes his article on the
‘Euro Area’s Economic Governance’by arguing that the
economic and monetary union of the EU needs more
legitimacy. He is right. But paradoxically in this case the
problem is not solved by identifying the solution. This is
because the path towards that solution is as important
as the solution itself; to see why this is so one has to go
back to the basics of optimum currency areas.
The theory on optimum currency areas uses four crite-
ria to determine whether countries should adopt a com-
mon currency: (1) extent of bilateral trade or integration;
(2) correlation of exposure to economic shocks; (3) cross-
border labour mobility; and (4) cross-border budgetary
transfers. These four criteria reflect the ability of countries
to adjust after they lose the possibility of using the
exchange rate as an instrument for adjustment. However,
the fourth criterion is not about ability to adjust per se,
but, more precisely, about making the task of adjustment
easier. Transfers soften the loss of income from economic
contraction. But the counterpart of an income-raising
transfer for a contracting country is, naturally, an income-
reducing transfer from an expanding country. Ultimately,
single currency areas or monetary unions require a cer-
tain degree of solidarity between the participating coun-
tries.
It is now clear that the seminal study that clinched the
debate on European monetary union, which was memo-
rably entitled ‘One Market, One Money’, was right on
many issues but wrong on two important aspects of the
design of monetary unions.
1
First, it claimed that the sin-
gle market had to be complemented with a single cur-
rency. As subsequent experience has shown beyond
doubt, this is not true or necessary. Many EU member
states are outside the eurozone yet they do not appear
to encounter any particular problems. Please note that
the question whether there are additional benefits to be
had from adopting a common currency is not the same
as the question whether it is possible to enjoy benefits
from the single market without having a same currency.
Second, it asserted that monetary union was not the
thin edge of the wedge of political union. Although the
first decade of the eurozone appeared to vindicate it,
recent events suggest that once a substantial part of a
single currency area runs into trouble, the typical adjust-
ment mechanisms may not be enough. The strong pull-
ing power of cross-border transfers may become
necessary to extract contracting countries from economic
mire.
Soon after the Maastricht Treaty was signed, it was
realised that the single currency would offer ample
opportunity for free-riding. Since interests rates would be
set by a common monetary policy, the countries with a
tendency to overspend would free-ride on the thrift of
more prudent countries. For this reason, the Stability and
Growth Pact (SGP) was adopted in 1997 with the objec-
tive of preventing this kind of free-riding. It did not work
because it had no teeth –its credibility was undermined
by the cavalier attitude of the large countries and
because it suffered the typical institutional weaknesses of
decision-making by committee. No one was responsible.
But the SGP was a preventive instrument. It was not a
remedial instrument for facilitating adjustment. Nor, have
the recent reforms of the SGP improved its capacity to
ease adjustment. It is not an exaggeration to claim that
all of the reforms of the past four years have focused lar-
gely on preventive action and in strengthening the pen-
alties and procedures in case of excessive deficit and
now debt and macroeconomic imbalances.
These preventive measures do not only reflect the per-
ceptions of policy makers but to a large extent they also
reflect the attention that the media and the wider public
have given to issues of responsibility and fairness. Mea-
A response to ‘How (Not) to Reform
the Euro Area’s Economic Governance’
Stefan Collignon*
*Collignon, S. (2013) ‘How (Not) to Reform the Euro Area’s Eco-
nomic Governance’, Global Policy, Vol. 4, Supplement 1, July
2013, pp. 50–57. DOI: 10.1111/1758-5899.12055
©2014 University of Durham and John Wiley & Sons, Ltd. Global Policy (2014) 5:2 doi: 10.1111/1758-5899.12125
Global Policy Volume 5 . Issue 2 . May 2014
256
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