Between ambition and realism – The future of a European Monetary Fund (EMF)

In March 2017, the European Commission President, Jean-Claude Juncker launched a wide ranging debate on the Future of the EU. Five specific areas have been further explored with dedicated reflection papers. One of them focused on the future of the Economic and Monetary Union (EMU) and the Commission’s ambition for its deepening with a long term perspective.

One element of the EMU paper is on what (new) role the European Stability Mechanism (ESM) could play in the context of further Eurozone integration, notably through the development of a stabilisation function.

Prior to the transformation of the ESM, major steps need to be taken in the short to medium term. Among them, the finalisation of the Banking Union which lacks a credible backstop for the Single Resolution Fund (which is expected to be one additional function of the ESM), a well functioning Capital Market Union (CMU) and further economic convergence of Eurozone countries.

The stabilisation function could be seen as the EMU component further protecting euro area countries and citizens against (asymmetric) shocks. However, a number of technical and political constraints need to be overcome through its design and conception, such as the need to avoid permanent transfers, ensuring it is fiscally neutral, minimising moral hazard and carefully designing access eligibility (e.g. compliance with fiscal rules, implementation of policies aimed at increased convergence, etc).

Subsequently, the ESM could become a European Monetary Fund (EMF) mirroring some of the functions of the International Monetary Fund (IMF); combining the traditional role of the ESM (granting loans to distressed countries) together with the operation of the stabilisation function. Concrete proposals for such a function could take the form of an euro area fiscal capacity, a public investment protection scheme or an unemployment insurance scheme, depending on which form of stabilisation sought.

The main added value of an EMF could be threefold. First, it will ensure more economic integration, solidarity and convergence, by intervening when (asymmetric) shocks hit and supporting economic re/convergence through the adjustment process.

Second, the EMF could be employed as a back-stop to the SRF when (asymmetric) shocks are linked to a systemic banking crisis. Third, the EMF could play a key role in the management of sovereign debt crises. In that context, it could also lead in the surveillance of fiscal rules in an independent way. Finally, an EMF will possibly ensure a more EU centric approach taking into account regional specificities (e. legal constraints of a currency union).

A number of issues remain open before an such institution could be established. In line with the cautious wording of the Commission, the legacy of the global financial crisis would need to be fully tackled or at least agreement (e.g. intergovernmental) should be sought on how the legacy will be dealt with and the timing for this to happen. Furthermore, legal adjustments at least to the ESM founding Treaty would be needed, which requires unanimity, and depending on the functions assigned to the EMF a change in the Treaties could be required. Finally its governance would best operate under majority rules.

One could also argue that the timeframe envisaged by the Commission (i.e. 2025) is rather short. If we consider that as today the EU has not yet found agreement on the Single Resolution Fund backstop, discussion on the third pillar of the Banking Union do not seem to advance and the Capital Markets Union is far from being achieved notably with the UK leaving.  But even if such steps would need to be taken before the ESM can be effectively pushed to the next level, this could be the right time to launch the debate.

*With thanks to Nick Theodoropoulos for his contribution to this post. 

Julien David