Allianz Global Investors’ Stefan Hofrichter considers the options for EMU
The European monetary union (EMU) is gradually moving towards a closer fiscal and political union, albeit on a bumpy path.
The main reason is that for both the peripheral and the core countries the costs of leaving the euro area are very high, and exceed the costs of staying within it.
Third-party analysts estimate that, if Greece were to leave the currency union, the immediate impact on the economy would be in the area of 25% to 50%, followed by a loss of 5% per annum in subsequent years.
The estimates for core EMU countries amount to 3% to 5% in the first year, and around 1% in subsequent years.
Exposure of EMU core countries to EMU peripheral countries has risen to very high levels. Germany has currently claims of roughly €700bn against the European Central Bank via the Target 2 system.
Part of these claims would be at risk if one or more peripheral countries were to leave the currency union – or if Germany was to leave. The political idea of a unified Europe would suffer a major set-back. Besides, a break-up could lead to political tensions and social unrest.
Required: austerity measures, growth initiatives and adjustments of the financial architecture
A bundle of measures is required to get out of the EMU debt crisis: firstly, fiscal austerity would be necessary in all countries, but especially in those countries which are suffering from imprudent fiscal policy.
Secondly, not debt-financed growth initiatives are required.
High public debt is to a large extent the consequence – rather than the source – of the problem and excessive austerity carries a risk of dragging down the economy too much. We are currently witnessing this effect in basically all peripheral economies.
Apart from this, structural reforms on both the product and labour markets need to be implemented in order to improve international competitiveness.
Admittedly, the implementation of structural growth initiatives will take time. However, the example of Ireland shows that any credible implementation may be rewarded rather quickly by the capital markets.
Still, all of the above is unlikely to be sufficient, as the markets have started to question the financial architecture of the euro zone.
Therefore, the currently existing problems of the euro-zone financial architecture need to be addressed and EMU should move closer towards fiscal and political union.
This implies: firstly, a deposit insurance scheme along a pan-European banking supervision of pan-European banks.
Secondly, a form of fiscal burden sharing, possibly in the form of a debt redemption pact as outlined by the German Council of Economic Experts.
According to this plan, public-sector debt in excess of 60% of GDP would be shared.
Thirdly, a further development of EMU requires a lender of last resort – typically, this role could be filled by the European Central Bank.