The European Union was born out of a desire for greater integration among European countries. The goal was to build a strong community that would form a united front coordinating responses to various matters. The Economic and Monetary Union (EMU) represents one step of this integration process. Forming an ensemble of coordination for economic, fiscal and monetary policy, the EMU aims at strengthening coordination among member states to bring stability to the union. However, this uniformisation is not without challenges. Lessons from past crises can tell us about the success of said coordination, which in turn may influence the future of the union.
A short introduction to the Economic and Monetary Union
The EMU was first established as an objective by the Maastricht Treaty in 1992. As part of a process of integration among Member States started since the creation of the European Economic Community in 1957, the EMU intends to harmonise and coordinate economic and fiscal policies while providing a common monetary policy and currency. In doing so, Member States are giving up part of their sovereignty over monetary policy in order to benefit the union as whole. Such integration is implemented in order to achieve greater economic stability as well as healthy and strong growth in the Union.
Heterogeneity of Member States and asymmetric exposure to risk
However, giving up such sovereignty was not achieved without reluctance and criticism from many. One of the main issues with a common monetary policy is that Member States are giving up on one way to influence their economy, that is they are giving up on a crucial tool when it comes to controlling the economy. Delegating this power to another entity has been the source of several criticisms, in particular from eurosceptic movements that present an exit of the Union as a move towards more sovereignty.
More importantly when it comes to common monetary policy, it is important to point out that while the goal of the EU is to create a united community, Member States are quite heterogeneous and as such can be impacted in a different way by the same exogenous shock. Hence, a common monetary policy may not be the best way to respond to the crisis, as Member States may require policies that are incompatible. Thus, while common policy may seem like a wise choice as it is implemented by an entity with the best interests of the Union at heart, it may lead to more problems on the individual Member States level.
Risk sharing vs. Risk reducing
Heterogeneity among member states is not only a danger because of asymmetric consequences of external shocks, but also because of the different attitudes and positions towards debt riskiness. Another great debate regarding the EMU and how to conduct monetary policy has arisen from the risk sharing vs. risk reducing question. While advocates for risk reducing policies require an abatement of the risky position of some Member States, risk sharing advocates on the other hand point out that countries facing economic hardship could benefit from more advantageous lending conditions, thus increasing their probability of a good recovery which benefits the Union as whole. Often, richer countries of the EMU tend to argue for risk reduction, while countries with less beneficial situations tend to argue in favour of risk sharing.
Finding the right balance between risk reducing and risk sharing has not been an easy task for the EMU. Up until recently, it was argued that risk reduction was necessary before any risk sharing tool could be implemented. This disagreement between risk sharing advocates and risk reducing ones hindered efficient cooperation among Member States. However, the COVID-19 pandemic changed this situation, as countries had to provide a prompt response to a shock that was affecting Member States disproportionally. In particular, coordination in fiscal, monetary policy and regulation was observed.
Such change in the approach on how to conduct monetary and fiscal policy when facing the pandemic can have several causes. Perhaps the nature of the crisis, or a better understanding of macroeconomics, can be the origin of such a shift. Or maybe policy makers learnt from the mistakes made during the financial crisis and decided to avoid repeating such missteps. Understanding where the change came from is of vital importance as it allows us to establish whether the shift in how monetary policy has been conducted with the COVID-19 crisis is temporary or has the vocation to inaugurate a new era for the EMU.
The EMU was born out of a desire to coordinate fiscal and economic policy while providing common monetary policy. Such centralisation of policy making is facing numerous challenges, as it attempts to provide a “one-shoe-fits-all” to problems that affect asymmetrically heterogeneous countries. Such heterogeneity is bound to lead to disagreements on policy-making. Yet, the COVID-19 pandemic was the theatre of a different dynamic; in particular, Member States were able to coordinate to bring a solution to this problem. Whether such coordination is born out of a true understanding of the challenges of the EMU, or whether it was a specific case for the pandemic will have a considerable impact on how monetary policy will be conducted in the future. And more importantly, it will have a considerable impact on the viability of the EMU.