Euro Reforms Collapse to Nothing

By Jakob Vestergaard - 28 June 2018
Euro Reforms Collapse to Nothing

This post is the fourth in a five part series from Jakob Vestergaard exploring reforms to the EMU that the Commission is hoping that member states will commit to at the end of June. Read part three here.

In the run-up to the EU summit that starts this afternoon in Brussels, the French finance minister, Bruno le Maire, made a strong plea that member states keep two of the largest agendas separate. It would be highly unfortunate, he said, if negotiations on the immigration crisis and the euro reforms were to blend. The French fear that Emmanuel Macron’s visions for enhanced European integration will fall flat, along with any remaining hope that the Commission and other likeminded parties might have that the summit could lead to substantive reforms of the EUs economic and monetary union (EMU).

The fact of the matter, however, is that the EMU reform project has already failed, even before the summit commences. The French-German agreement announced last week reduced the integration agenda almost beyond recognition – and yet the agreement was heavily criticized by member states that are skeptical of further European integration for the few substantive elements it had. The music likely will play on for a while still, but the sun is slowly descending on any notion of comprehensive reforms aiming at bolstering the resilience of the euro.

The Franco-German agreement

Angela Merkel and Emmanuel Macron convened last week in a castle in the small German city, Meseberg, just north of Berlin, to carve out a set of Franco-German positions on the main items on the agenda for this week’s EU summit. In the last few years, we’ve seen a new trend that international summits end without joint declarations, so Merkel and Macron deserve praise for agreeing to a more than six pages long declaration, laying out joint perspectives on all the largest issues, from immigration and security to banking union and a potential Eurozone budget. 

With respect to the more than five year long process through which the Commission has sought to inspire member states to “complete the EMU”, three elements of the Franco-German agreement stand out: that there should be a Eurozone budget, that a fiscal backstop for the banking union should be provided, and that a European Monetary Fund (EMF) should be established, to take over from and expand the functions of the current European Stability Mechanism (ESM).

Any talk of new budgets is hard to sell to German voters and politicians, so Merkel has moved further here than many expected. It should be mentioned, however, that while the French want the Eurozone budget mainly as a means to pursue macroeconomic stabilization policy to assist member states that face a recession, the actual phrasing of the Meseberg declaration focuses not on stabilization, but on competitiveness through investment in innovation and human capital. The notion of instituting a paneuropean unemployment insurance scheme also gets a mention, but it is stressed that any such arrangement would have to be construed in a manner that precluded any form of fiscal transfers across borders.

The Meseberg agreement states that the Eurozone budget should be set up and operational by 2021, but the issue of how large the budget would be is not addressed. The declaration does indicate briefly, however, that some of the funding should come from EU tax levies, such as through a European tax on financial transactions. For the French, crossing the institutional “hurdle” of being able to collect European taxes is a deeply-felt desire and long-held dream.

The banking union has been criticised for being seriously impeded by the low scale of funds at the disposal of the Single Resolution Fund (SRF), to deal with failing banks. On this point, the Franco-German agreement proposes that a fiscal backstop is provided  – to supplement the funding accumulated over the years through continuous contributions from Europe’s banks – in and through the European Stability Mechanism (ESM). More specifically, the proposal is to roughly double the financial resources of the SRF, such that its total financial resources reach more than 100 billion euros by 2024 (as opposed to the currently envisaged 55 billion). In anticipation of predictable objections, the agreement stresses that the backstop for the banking union will be fiscally neutral; any funding dispersed through the ESM, for recapitalization or resolution of banks, would eventually be financed by extraordinary contributions from the banking sector, over a period of three to five years.

The third and final area of noteworthy agreement amongst the French and the German relates to a boosting of the role of the ESM in the institutional set-up of the EMU. Needless to say, the proposed fiscal backstop for the banking union is a central component in that regard, but there are other important elements at play. The Meseberg declaration states that any disbursement of funds from the ESM will be accompanied by strict conditionality. Moreover, in relation to a new modality of support that proposes to target member states experiencing temporary liquidity problems, the Franco-German agreement stipulates that only fiscally sound member states would be eligible.

The considerable emphasis on conditionalities and eligibility criteria relates crucially to German concerns that without such caveats, ESM support may inadvertently weaken the incentives member states have to manage their public finances prudently and “get their houses in order”. At the end of the day, this is why the German’s see a point in boosting the ESM symbolically: renaming it as the European Monetary Fund and making it a vehicle for fiscal disciplining of all member states, is a perfect match for Germany’s Ordoliberal sentiments.


Most analysts agree that the Franco-German agreement falls far short of what can be considered adequate. In Pierre Briancon’s analysis, the agreement is best depicted as “three fudges and a funeral”. The proposed Eurozone-budget is a fudge, he says, in the sense that the French and the Germans have zero agreement on what the funds are to be used for; there is an enormous difference between Merkel’s wish for modest resources targeted at investment funding and Macron’s urge to create a macroeconomic stabilization policy, with funding at the scale of one or several percentages of Eurozone GDP.

The envisaged reforms of the ESM is also a fudge, Briancon argues.  Here too, the French and the German have fundamentally different and opposing approaches. The German focus on conditionality and eligibility criteria will undermine the stability enhancing functions of a revamped ESM, when and if a new crisis occurs. But the largest fudge, Briancon says, is the most dangerous one. Is Merkel playing along with key aspects of the French agenda (such as the launch of a Eurozone budget) in the near-certain knowledge that she can safely leave it to other member states to block these elements?

As for the funeral, the reference here is to the European deposit insurance scheme (EDIS). Observers had hoped that, in the absence of substantive progress, the parties might at least be able to lay out some plan for the negotiating process going forward. The complete and utter silence on this in the Meseberg declaration, doesn’t bode well for EDIS. On the contrary, it is widely interpreted as effectively kicking EDIS into the long grass, with poor prospects of a comeback any time soon.

One of the most remarkable comments on the French-German agreement came from Guntram Wolf, director of Bruegel. Wolf’s critique is particularly interesting because Bruegel is not only one of the world’s highest-ranked think tanks, but also – in EU matters – a professional intelligentsia of the euro project, with financial contributions from a number of member states and central banks.  In a live interview with Bloomberg, a visibly agonized Guntram Wolf explained that those components of the Franco-German agreement that relates to the banking union are “very weak”. A doubling of the funding for the resolution mechanism, as the agreement proposes, is far too little; the financial firepower of the resolution fund must be much larger to make the banking union an effective and credible construction. Wolf’s critique on this point is particularly damning because EU diplomats allegedly consider this the only potential “Golden Egg” of this EU summit.

Wolf further explained that although there was not much detail in the agreement, it seems all but certain that decisions to disperse funds from the ESM to the resolution mechanism, will be intergovernmental, such that no funds can be dispersed without the explicit backing of each and every member state. A decision-making process that accords de facto veto to all member states is utterly useless, however, in matters of bank resolution, where authorities often have only a few days to devise a resolution plan. Ultimately Wolf’s exasperation is down to two things, in other words: the fiscal backstop is too limited in size and will likely be far too slow on its feet.

Last but not least, it should be stressed that the Franco-German agreement flatly rejects the Commission’s proposal to promote issuance of securities based on pools of European government bonds, the so-called sovereign bond-backed securities (SBBS). This is remarkable because the creation of a paneuropean ‘safe asset’ was seen by the Commission as absolutely key in its efforts to break the bank-sovereign doom loops which so threatens the cohesion and resilience of the euro. When markets are gripped by panic, they would be able to find a safe haven in the proposed paneuropean debt securities, instead of going the traditional – highly destabilizing – route, out of Southern European bonds into German bunds. This idea now seems dead and gone. The proposal “has significantly more disadvantages then potential benefits and should not be further pursued”, the France-German agreement states laconically.

Resistance from north

Although the French-German agreement thus in many ways is less than meets the eye, it has nevertheless come under heavy criticism from other member states for being too much. On behalf of no less than 12 member states, the Dutch finance minister Wopke Hoekstra sent a letter last week in response to the Meseberg declaration, to Mario Centeno, head of the eurogroup, to stress that the coalition disagrees fundamentally with key aspects of the French-German agreement. The coalition – known as the Hanseatic league – was established in March, by Holland, Ireland and the Nordic and Baltic states, and later expanded to encompass the Benelux countries, Austria and Malta. These countries challenge the notion that a eurozone budget is necessary or even desirable. From the perspective of these countries, a eurozone-budget is a dangerous development, because it may undermine the incentives member states have to balance their budgets. In their view, the proposed eurozone-budget takes the EMU reform process in the exact opposite direction of what is needed. The way forward is not moral hazard through various modes of risk sharing across member states, but reinforced fiscal prudence for each and every member state.

French finance minister, Bruno le Maire, reacted sharply to the coalition’s letter. In a series of remarkable comments earlier this week, le Maire described the eurozone-budget as “non-negotiable” for the French. Without it there would be no EMU reform deal at the summit, it was implied.

So what can we expect from the coming two days of high-level negotiations in Brussels? Much suggests that the EMU reform agenda will have a tough summit. Just yesterday, several media reported that Mario Centeno has allegedly sent a letter to Donald Tusk, head of the European council, stressing that although he personally supports the French-German agreement, he feels compelled to communicate that there is next to no consensus amongst eurozone countries on the EMU reform process. In fact, the only thing that member states agree, Centeno notes, is that the resolution mechanism needs a fiscal backstop, which should be provided by the ESM. 

In spite of more than five years of intensive preparation by the Commission, and its persistent nudging and pushing of the EMU reform agenda, it seems likely that the EU summit identified as the key milestone in the process, will end up producing despairingly meager results, if any at all.




Image credit: Peter Roberts via Flickr (CC BY 2.0)


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