A Monetary Union for All EU Members

EMU is in much better shape today than it was when it was hit by the global financial crisis in 2008. Stabilising mechanisms have been put in place, reducing perceived fragility. Moreover, the European Central Bank (ECB) has, with its sovereign debt purchases, created fiscal space for countries with weak public finances. At the same time, however, it also created implicit liabilities for other member countries. This makes adopting the euro a less attractive option for Sweden. Furthermore, the ECB’s policy has thus far been conducted in an environment of low inflation but will become increasingly difficult as inflation rises.

In this European Policy Analysis, Karolina Ekholm, Professor in International Economics at Stockholm University and Director General of the Swedish National Debt Office, discusses ways to solve this problem. One option would be to introduce a central fiscal capacity, alleviating ECB’s dilemma of having to choose between a sovereign debt crisis and losing control over inflation. However, this would entail fiscal transfers between members – a highly unpopular step in parts of the union – and could potentially even lead to monetary disintegration.

A well-functioning macroeconomic stabilisation policy should therefore build on the existing fiscal rules to enforce fiscal discipline. This requires both simplification and flexibility within the current framework, focusing on an expenditure rule rather than the current medium-term objective. The rules on deficits and debt – 3 and 60 percent of GDP respectively – no longer make much sense.

Above all, the most pressing reform concerns breaking the ’doom loop’ between banks and sovereigns. Even though common bank supervision may, over time, even out risk levels across national banking systems, sovereign debt still tends to end up on the balance sheets of domestic banks.

The main question, not least for those Member States who retain their own currencies, is whether monetary union can promote prosperity for its citizens. The jury is out as to whether EMU can be reformed such that it also improves its members’ economic performance.

This paper was written before Ekholm took on the position as Director General of the Swedish National Debt Office.