Blog Post

Only teamwork can put the Eurozone on a steady course

European policymakers returning to work after the summer recess are not being greeted with good news. In the post-referendum debate in June, the idea that emerged was that the voters in France and the Netherlands had primarily expressed dissatisfaction with Europe’s economic performance and that growth was needed to restore the European Union’s legitimacy. Yet […]

By: Date: August 29, 2005 Topic: European Macroeconomics & Governance

European policymakers returning to work after the summer recess are not being greeted with good news. In the post-referendum debate in June, the idea that emerged was that the voters in France and the Netherlands had primarily expressed dissatisfaction with Europe’s economic performance and that growth was needed to restore the European Union’s legitimacy. Yet recently released statistics show that even before the recent hike in oil prices, growth in the EU as well as the eurozone barely exceeded 1 per cent.
Neither monetary nor fiscal policy can be expected to redress the situation. The eurozone’s aggregate budget deficit is approaching 3 per cent and the European Central Bank is now wary of potential second-round effects of the increase in oil prices. The consensus is therefore that, more than ever, growth can only be expected from structural reforms. There is, however, wide agreement that the Lisbon strategy adopted five years ago has not delivered the expected boost to reforms. Indicators confirm that economic reform in Europe has neither accelerated nor become more coordinated since 2000. In fact, Romain Duval and Jørgen Elmeskov of the Organisation of Economic Co-operation and Development find in a recent paper that reform has slowed in the 2000s, especially in the eurozone.
The revamped Lisbon strategy adopted in spring by the European council to co-ordinate reforms is unlikely to deliver more. The set of objectives has been narrowed and the procedures streamlined but the strategy continues to lack incentives. If anything, the Commission’s new reluctance to “name and shame” the laggards has removed one of the few incentives that there were. EU member states may decide to reform on their own but the EU framework hardly matters. After all, the agenda 2010 of Gerhard Schröder, German chancellor, did not even refer to the EU strategy. Does it matter? The answer differs for the EU as a whole and for the eurozone. Assume for example, that country A undertakes reforms that lower structural unemployment and increase productivity, while another, B, does nothing. Reform in country A affects country B through trade channels but without diminishing the gains to country A. A permanent lowering in unemployment or a rise in productivity are benefits in their own right, whatever the consequences for the neighbours. Country B could also be affected as voters observe the effect of reform across the border and make decisions accordingly. To risk being followed by neighbours, however, does not reduce the incentive to reform. The upshot is that the rationale for co-ordinating reform policies within the EU is weak. There is nothing wrong in fostering policy learning and league tables, but there is not much to be expected from it. What about the eurozone? Let us again suppose A reforms and B does not.
Lower structural unemployment and higher productivity translate into lower inflation – at least temporarily – in country A, thereby lowering the average eurozone inflation rate. As the ECB targets inflation, this in turn translates into lower interest rates. Country B’s macroeconomic policy environment is thus modified by its neighbour’s policy. But average inflation and interest rates remain higher than if both countries had reformed or if country A had had monetary policy autonomy. For B’s government, there is a windfall. For A’s government, some of the benefits of reform are lost.
The difference with the EU case comes from the fact that eurozone countries share an interest rate that is set by the ECB with respect to the average inflation rate. This creates an interdependence that extends beyond the usual realm of monetary and fiscal policies and affects structural policies too. This interdependence matters especially for measures that are costly in the short run, because a lower interest rate can help to offset their adverse effects and improve their overall balance. This is the case of many reforms. Labour market reforms may increase unemployment before they lower it because they create anxiety and lead firm to shed labour faster than they create new jobs. Product market reforms may also depress growth because incumbents react immediately to the loss of rents while entry only develops over time. This is why reform is easier when accompanied by monetary expansion (to offset the negative effects of reform on aggregate demand) and fiscal stimulus (which also helps to compensate the losers). This kind of strategy can be followed outside the eurozone, not within it – unless reforms are co-ordinated.
The conclusion is twofold. First, the case for co-ordinating reform policies is weak for the EU as a whole but stronger for the eurozone. Second, reform in the eurozone would benefit from being able to rely on macroeconomic support. The EU started taking these requirements into account in last spring’s reform
of the stability and growth pact. It is now accepted that growth-enhancing reforms can be a motive for temporarily deviating from the “close to balance” target the members are committed to, or for delaying the convergence towards it. Although this provision does not give much additional margin of manoeuvre to the big-deficit countries, it is a step in the right direction.
More is required. First, the institutional framework needs to be adapted. The eurozone finance ministers who meet in the eurogroup do not set the reform agenda. The heads of government who are in charge of that agenda never meet in eurozone format. Neither do the labour or economy ministers. A eurozone meeting of the heads of government would remind them of their responsibility for the sustainability of the currency area they have created, and would allow them to discuss their reform agendas and confront the effects of their interdependance.
The other change concerns the ECB. The Central Bank is long on exhortations but short on commitments. It should explicitly state that, without prejudice to price stability, it will back reforms that lower structural unemployment or put the eurozone on a higher growth path. ECB officials have already acknowledged the complementarities between monetary policy and structural reforms and have hinted at the additional room of manoeuvre that the latter would create for monetary policy. The ECB should go further and unequivocally recognise that, provided that governments act, monetary policy would be able to support their action. Such a promise would involve a risk. The question, however, is whether it is preferable to take the alternative risk of remaining in a deadlock that would ultimately undermine the sustainability of the monetary union.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article
 

Blog Post

Will European Union recovery spending be enough to fill digital investment gaps?

The recovery facility will boost digital transformation, but questions remain whether it will be sufficient to achieve Europe’s digital ambitions.

By: Zsolt Darvas, J. Scott Marcus and Alkiviadis Tzaras Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 20, 2021
Read about event More on this topic
 

Upcoming Event

Sep
1
12:30

The EU recovery fund - state of play and outlook

Bruegel Annual Meetings, Day 1- In this session we will discuss the EU recovery fund, its state of play and outlook.

Speakers: Nadia Calviño, Karolina Ekholm and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

Sep
2
10:00

Conversation on the recovery programmes

Bruegel Annual Meetings, Day 2- In this session, we discuss the recovery programmes.

Speakers: Maria Demertzis and Tadeusz Kościński Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event
 

Upcoming Event

Sep
2
13:00

European banks: under global competitive pressure?

Bruegel Annual Meetings, Day 2 - European banks have lost stature and remain generally low-profitability, low-valuation in comparison to their global peers. Is that a problem? If so, what can EU policymakers do to address it?

Speakers: José Antonio Álvarez Álvarez, Mairead McGuinness and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
2
15:45

Blending physical and virtual: shaping the new workplace

Bruegel Annual Meetings, Day 2 - This panel will cover the changes the COVID-19 pandemic made to our workplaces, and what to expect in the near future.

Speakers: Nicholas Bloom, Michael Froman, Mario Mariniello, Sara Matthieu and Luca Visentini Topic: European Macroeconomics & Governance Location: Academy Palace
Read about event More on this topic
 

Upcoming Event

Sep
3
09:00

The role of the EU's trade strategy for an inclusive and sustainable recovery

Bruegel Annual Meetings, Day 3 - We are delighted to welcome Valdis Dombrovskis, Executive Vice President of the European Commission for An Economy that Works for People to talk about Europe's trade strategy.

Speakers: Valdis Dombrovskis, Alicia García-Herrero and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
3
10:15

Conference on the Future of Europe: envisioning EU citizens engagement

Bruegel Annual Meetings, Day 3 - Panellists will discuss different options and what they may entail while revisiting the debates on the future of Europe at national and EU-level that have been conducted thus far.

Speakers: Caroline de Gruyter, Kalypso Nicolaïdis, Niclas Poitiers and György Szapáry Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read article Download PDF
 

Policy Contribution

A new direction for the European Union’s half-hearted semiconductor strategy

The EU needs a more targeted strategy to increase its presence in this strategic and thriving sector, building on its existing strengths, while accommodating its relatively low domestic needs.

By: Niclas Poitiers and Pauline Weil Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 15, 2021
Read article More by this author
 

Blog Post

Fit for 55 marks Europe’s climate moment of truth

With Fit for 55, Europe is the global first mover in turning a long-term net-zero goal into real-world policies, marking the entry of climate policy into the daily life of all citizens and businesses.

By: Simone Tagliapietra Topic: Energy & Climate, European Macroeconomics & Governance Date: July 14, 2021
Read article More on this topic
 

Blog Post

Fair vaccine access is a goal Europe cannot afford to miss – July update

European countries must do more to tackle the vaccine uptake gap. Vaccination data should be published at the maximum granularity level so researchers and local decision-makers can monitor progress.

By: Lionel Guetta-Jeanrenaud and Mario Mariniello Topic: European Macroeconomics & Governance Date: July 14, 2021
Read article More by this author
 

Blog Post

SPACs in the gap

Special-purpose acquisition vehicles could fill a gap in European equity markets and lure risk-averse investors off the sidelines.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 13, 2021
Read article More on this topic
 

Blog Post

A breakdown of EU countries’ post-pandemic green spending plans

An analysis of European Union countries’ recovery plans shows widely differing green spending priorities.

By: Klaas Lenaerts and Simone Tagliapietra Topic: European Macroeconomics & Governance Date: July 8, 2021
Load more posts