02 February 2018

ECB's Cœuré: The euro area’s three lines of defence

Speech by Benoît Cœuré, Member of the Executive Board of the ECB, at the conference “Deepening of EMU”, in which he outlined the requirements than any euro area reform will have to pass: the three “lines of defence” that any well-functioning monetary union depends on.

[...]Flexible markets form the first line of defence.

They are indispensable for a currency union. They reduce the need for macroeconomic stabilisation and curb contentious debates about crisis management. Markets that can absorb shocks efficiently do not waste costly political capital. And they create more policy space in downturns, for both fiscal and monetary policy. [...]

The other key domain to spur the catalyst function of our market economies is the Single Market. It is incomplete as we all know. Take services as an example. They account for over 70% of the EU’s GDP and an equal share of its employment. But we still face significant barriers when it comes to cross-border service provision in the EU. The Services Package that was adopted about a year ago was a step in the right direction but more needs to be done.

Efficient and integrated financial markets are part of the first line of defence. In the United States, around 60% of a shock to a state’s GDP is cushioned by financial markets. In the euro area, the share is currently closer to 20%. Country-specific shocks remain unsmoothed to a large extent, mainly because cross-border equity risk-sharing is hugely underdeveloped in Europe.

A true capital markets union could significantly help to diversify and reduce risk. It would thereby limit the financial burden to be levied by governments in the case of adverse shocks. And it would broaden the scope of monetary policy transmission beyond the banking sector, making policy less vulnerable.

Finally, to avert banking collapses, governments in the past were forced to disburse large sums of public money in the pursuit of economic and financial stability. Completing banking union will reduce risks for taxpayers and break the remaining link between banks and national governments. A European deposit insurance scheme is a precondition for a truly integrated banking system and single money. Let us not forget that 86% of our money is created by commercial banks. The transmission of the ECB’s monetary policy will always be incomplete as long as differences in depositor confidence prevail across the euro area.

The second line of defence relates to the role of governments.

Even the most flexible and efficient markets cannot fully absorb very large shocks without imposing economic hardship on a considerable number of people. In other words, flexible markets come at a price. They increase uncertainty for employees and often require relinquishment.

Uncertainty, for example, is born of the fear of a loss of employment or of not being able to respond to today’s fast pace of change. But it is also born of the fear that governments themselves have been pushed to the sidelines as globalisation has proceeded. Recent election outcomes around the world bear witness to this fear. The more exposed individuals are, the more likely a political backlash.

Governments can mitigate these effects. Unlike the United States, however, the European Union is not a federation. This means that, as a rule, stabilisation and the provision of security in the form of social services takes place first at national level. Keeping governments solvent is a precondition for achieving that. As we saw during the crisis, if perceptions of sustainability among markets decline, then counter-cyclical spending can quickly become constrained. So we need to regain fiscal space, which means building adequate national fiscal buffers.

The current broad-based economic expansion is contributing a lot to this end. But many countries are emerging from the crisis still bearing legacy burdens that could take decades to resolve. This leaves us vulnerable to divergence and fragmentation when a crisis strikes – and in some ways, even more so than before.

Fiscal consolidation therefore needs to go hand in hand with efforts strengthening our area-wide defences. Of course, the ESM is already an important safeguard. But we need to enhance its competences in the field of crisis management and make it more agile. This includes making full use of its existing instruments, such as the direct bank recapitalisation tool and precautionary financial assistance, and moving away from the unanimity requirement. And in the long run, it means bringing the ESM into the community framework. The stability of the euro area cannot be in the hands of one, or a few, Member States and their parliaments. Ultimately, the ESM needs to be accountable to the people of Europe.

But union stabilisation cannot stop with the ESM. The euro area needs a fiscal instrument that can help it cope with large shocks without having to rely excessively on the ECB.

Such an instrument would be the third line of defence of our monetary union.

It would support aggregate demand in countries experiencing a crisis, drawing on common funds. It would thereby provide an additional layer of stabilisation that safeguards trust in national policies. EU solidarity would then take on a whole new meaning. [...]

Full speech

© ECB - European Central Bank