September 13, 2015 / 8:10 AM / 2 years ago

Divided on diagnosis, EU ponders euro zone reform

VIENNA (Reuters) - Overshadowed by Europe’s twin dramas over refugees and Greek debt, debate is bubbling up over how to strengthen European monetary union after six years of debilitating crisis.

A rainbow is seen behind European flags during a euro zone EU leaders emergency summit at the European Council headquarters in Brussels, Belgium, July 7, 2015. REUTERS/Eric Vidal

It pits those who believe the 19-nation euro zone needs to take a bold step toward federal integration to survive as a stable currency area on one side, against those who argue that with scant public or political appetite for sharing more sovereignty, Europe just has to keep muddling through with modest, incremental change.

The heads of five European Union institutions proposed in June a series of steps over the next two years to reinforce the bloc’s banking union, better integrate its capital, energy and digital markets, foster economic competitiveness and counter macroeconomic imbalances without changing the EU treaty.

Even those relatively low-key proposals face resistance, notably in Berlin, where opposition to any further sharing of liability at a European level is deeply ingrained.

More ambitious ideas are also blossoming in Paris and at European Central Bank headquarters in Frankfurt.

Within days of the euro zone clinching a deal to keep Greece in the currency area with a third bailout, a French minister and a senior central banker called for a euro zone treasury with its own budget and parliament and power to oversee national economic and fiscal policies.

Economy Minister Emmanuel Macron said Paris and Berlin would have to shed past inhibitions about sovereignty and risk-sharing to “reinvent” Europe and make the euro zone work.

“For the French, this means we must carry out reforms that break old habits once and for all. It also means the Germans will have to break taboos,” he told the Sueddeutsche Zeitung.

“If the member states are not ready for any form of financial transfer in the monetary union, as is the case today, then you can forget the euro and the euro zone.”

Macron, a business-friendly young reformer in the Socialist Paris government, said a European economic government led by a super-commissioner should be able to borrow on the markets and have a separate budget bigger than the European Union’s roughly 1 percent of gross domestic product.

Separately, European Central Bank executive board member Benoit Coeure called for the creation of a European finance ministry under the oversight of the European Parliament.

It would be responsible for preventing economic and fiscal imbalances, managing crises and running a euro zone budget, as well as representing euro area governments in international economic and financial institutions.

The response from Germany, the euro zone’s leading economic and political power, has been cautious but not dismissive.

Chancellor Angela Merkel said strengthening the euro area was likely to be an incremental process, since few governments were keen to change the EU’s founding treaty, requiring ratification by referendum in several countries.

Berlin and Paris were working on improving a European banking union, building a capital markets union and developing more effective governance to promote economic competitiveness, she said, and some extra financial resource could be then considered to help countries reform.

It remains unclear whether France will be more willing than in the past to pool more sovereignty over fiscal and economic policy and whether Germany would then be willing to share more risk through a common euro zone budget or debt mutualization.

For now, Berlin is balking even at a modest proposal for joint reinsurance of national bank deposit insurance schemes.

The rise of anti-euro populist parties in many member states, including France, makes closer integration of the euro zone more politically risky, though not yet impossible.

Working out what to fix is made harder because economists and politicians still don’t agree what caused the crisis.

The standard German narrative blames profligate governments and bloated labor costs in southern countries. Hence Berlin’s prescribed solution is austerity to shrink deficits and lower wage costs to restore competitiveness.

But many economists say Germany’s export boom and wage restraint opened imbalances in the euro zone, along with a surge of private debt in peripheral countries after a construction boom fueled by low interest rates and reckless lending.

In that case, the solution would lie in boosting domestic demand in Germany and finding ways to write off or mutualize some of the debt overhang in the crisis countries.

In his first state of the union address last week, European Commission President Jean-Claude Juncker acknowledged that euro zone economies had diverged during the crisis, with unemployment and inequality rising and growth potential shrinking, fuelling public doubts about the currency.

Juncker, one of the architects of the 16-year-old euro, promised to work from mid-2017 on creating a euro zone treasury, built on the bloc’s existing bailout fund, the European Stability Mechanism, to underpin the economy.

Such changes, along with making European oversight of economic and fiscal policies more binding, would require changes to the EU treaty that neither Germany nor France wants to raise before national elections in 2017.

Economists such as Paul de Grauwe of the London School of Economics worry that the modest economic recovery now under way will cause complacency, discouraging the architectural changes needed to correct the design flaws of the monetary union.

He advocates pooling legacy national debt under a common euro zone fiscal authority to reduce countries’ exposure to market swings and creating an insurance mechanism to counteract economic shocks within the euro area.

Other ideas raised at a conference hosted by Austrian central bank on completing the monetary union included a common euro zone unemployment insurance scheme in crisis times, giving Brussels more power to make countries correct macroeconomic imbalances, and even - heretically - borrowing from the ECB to fund public investment in infrastructure.

Austrian central bank governor Ewald Nowotny, who hosted the event, welcome new ideas to address the institutional flaws of the euro area but warned against what he called “alarmism” and “dramatic undertones”.

“It’s especially dangerous to say that we have to have radical change otherwise everything will die,” he said. “We know we will not have radical change in the near future... So the logic would be that Europe would have to collapse.”

Writing by Paul Taylor, editing by Larry King

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