The European Commission’s response to the 2008 financial crisis was slow and partial. Fear of moral hazard fueled mistrust and decisions were made on an ‘ultima ratio’ basis. But, having learned from these missteps, the European Union’s response to Covid-19 was swift, activating the Pandemic Emergency Purchase Program in March 2020 and introducing the Recovery and Resilience Facility into under the Next Generation EU fund less than a year later.
The Russian invasion of Ukraine posed a new crisis. Although it took only a few days to reach the unilateral decision to impose sanctions on Russia, overcoming dependence on Russian oil and gas imports will be a longer-term challenge, deeply linked to the transition to a net zero economy. This is just one example of how the impending climate emergency will also lead to global stagflation.
Will these shocks lead to much-needed reforms for the euro area and the enlarged EU? Or will they catalyze fragmentation between member states, turning cracks into cracks? This was a key topic of debate at an OMFIF roundtable in March, with a discussion moderated by Marco Buti, Chief of Staff to the European Commission’s Economics Commissioner and former Director General of the EC for economic and financial affairs.
Roundtable participants noted that exogenous shocks have an asymmetric impact on EU Member States, resulting in common but differentiated impacts. As a result, moments of crisis are critical moments for the EU, either bringing member states closer together or pushing them apart. Although disruptive, crises can present opportunities to move quickly and decisively toward reform.
The emergency fiscal and monetary measures taken by EU institutions in response to the pandemic indicated that there was a “pilot in the plane”, reassuring markets – and the public – that the Europe remained united. This, in turn, has helped to combat financial fragmentation, by reducing sovereign bond yield spreads across the euro area.
The NGEU coordinated fiscal expansion across the EU, boosting public spending on green, sustainable and digital projects to encourage resilient and equitable growth. If the NGEU ends in 2026 as planned, the crucial next step will be to translate this temporary solution into lasting change. Similarly, the PEPP, while necessary to support financial markets against pandemic-related shocks, has proven that monetary policy has limited leeway to address underlying economic issues.
While important first steps towards deeper economic union, these programs alone will not be enough to ensure Europe’s unity and resilience in the context of an increasingly antagonistic international environment.
For Buti, the quality of any new policy measure matters more than the quantity. Finer policies could, for example, be designed to fund productive investment, rather than fuel demand inflation in broad strokes. As for the next steps, the capital markets union, banking union and a more permanent fiscal facility were among the reforms discussed.
First, Europe needs to put in place a functioning Capital Markets Union. The CMU initiative has been discussed since the 2008 financial crisis, gaining momentum after the UK’s departure from the EU. It is now more important than ever to meet the financing needs of economic recovery from the shocks of the pandemic and war, and to finance the green and digital transitions. The EU has an opportunity to capitalize on the success of the NGEU to deepen onshore capital markets and facilitate productive investments under the six pillars of the RRF.
Second, the banking union is necessary to ensure that banks in the EU are well regulated, supervised and sufficiently resilient in the face of external disturbances. The Single Supervisory Mechanism and the Single Resolution Mechanism entered into force in 2014 and 2015, respectively, with the automatic admission of all euro area members. However, the European deposit insurance scheme proposed by the Commission – intended to protect depositors, improve financial stability and reduce the moral hazard of banks – has not yet been adopted.
Unlike the CMU, which has largely been blocked by technical obstacles, progress towards a more comprehensive banking union has been blocked by a lack of political momentum. This is probably the most difficult aspect of comprehensive financial reform. Roundtable participants discussed how the political roadblock could now be less of a problem due to the pressing need for Europe to gain momentum on the global stage.
Finally, as public debt has been inflated by the pandemic fiscal stimulus, there is a need to revise the EU debt anchor. The so-called “escape clause” of the Maastricht Treaty rules was implemented at the start of the pandemic, de facto suspending the rules of the Stability and Growth Pact. This opportunity should be used to reform the EU’s budgetary architecture. Any fixed debt ceiling will need to be both credible and realistic.
Faced with a changing world, institutions must evolve with it. The EU has the opportunity to use these crises to implement much-needed reforms within its institutions and Member States. As fiscal and monetary levers run out of steam, new instruments are needed to finance fair and resilient growth in Europe. If these vulnerabilities are not taken into account, it is hard to believe that the EU can play a credible geopolitical role when exposed to all the winds of a crisis.
Ellie Groves is Managing Director and Taylor Pearce is an Economist at OMFIF’s Institute for Economic and Monetary Policy.