The Euro@20: A critical assessment

To review the strengths, weaknesses and robustness of the Euro system after 20 years is an enormous project. This paper picks out three of the less usually discussed themes, at least in this context. It focuses on the policy lessons and where design improvements are needed. It makes three points. i) the achievements in the single market are palpable and substantial, but they derive more from investment and productivity growth than they do from trade as such. This carries its own dangers: if the markets are allowed to use low real wages to substitute cheap labour for more expensive capital, these gains will be lost. ii) The Euro area needs to reassess its use of monetary policy, and the need to introduce an explicit financial stability mandate. We find that financial stability and traditional monetary objectives can be achieved without one limiting the achievement of the other because the ECB has new policy tools derived from the regulatory metrics introduced to handle the expanded balance sheets of the post-crisis macro-prudential framework. iii) Fiscal governance remains a crucial issue. The North remains divided from the South over how much coordination (possibly loans or transfers) to allow. But, despite the Euro system being based on the separation of monetary and fiscal powers, the economic consequences of using those powers cannot be separated in practice. More active debt management policies offer a better and more robust way to deal with this difficulty. This document was provided by Policy Department A at the request of the Committee on Economic and Monetary Affairs.

To review the strengths, weaknesses and robustness of the Euro system after 20 years is an enormous project. This paper picks out three of the less usually discussed themes, at least in this context. It focuses on the policy lessons and where design improvements are needed. It makes three points. i) the achievements in the single market are palpable and substantial, but they derive more from investment and productivity growth than they do from trade as such. This carries its own dangers: if the markets are allowed to use low real wages to substitute cheap labour for more expensive capital, these gains will be lost. ii) The Euro area needs to reassess its use of monetary policy, and the need to introduce an explicit financial stability mandate. We find that financial stability and traditional monetary objectives can be achieved without one limiting the achievement of the other because the ECB has new policy tools derived from the regulatory metrics introduced to handle the expanded balance sheets of the post-crisis macro-prudential framework. iii) Fiscal governance remains a crucial issue. The North remains divided from the South over how much coordination (possibly loans or transfers) to allow. But, despite the Euro system being based on the separation of monetary and fiscal powers, the economic consequences of using those powers cannot be separated in practice. More active debt management policies offer a better and more robust way to deal with this difficulty. This document was provided by Policy Department A at the request of the Committee on Economic and Monetary Affairs.