A better EMU blueprint: the current system is 'conceptually incomplete and functionally ineffective.'.

• Author: Papademos, Lucas

When European leaders decided in the 1990s to create a monetary union and introduce a single currency, the euro, it was understood that this undertaking was part of a more ambitious and longer-term project of establishing a broader and closer union of member states' economies and policies. They were also fully aware that, historically, a single political or national entity, including a reasonably integrated economy and a single fiscal policy, almost always preceded or coincided with the adoption of a single currency.

Since a political and economic union of the European Community member states was not a realistic, or even a desirable, option in the 1990s, leaders adopted the alternative and unprecedented (with few exceptions marred by failure) approach of introducing the euro as the first and central element of an intended plan for creating "an ever-closer union."

The introduction of a single currency was economically desirable as the essential complement of a single market for goods, services, labor, and capital, which has been a main European policy objective. It was convincingly argued and politically accepted that the completion and efficient functioning of a single market required a monetary union and a single monetary policy geared to maintaining price stability across member states. It was envisaged that the other components of a more complete, or genuine, union would follow at the right time. Hence, economic reasoning and political reality jointly defined the blueprint for and the road map to the Economic and Monetary Union that was established in Europe in 1999.

To be sure, it was also realized from the outset that monetary union could not function efficiently and preserve price stability effectively in the absence of a framework which would ensure that national fiscal policies would be consistent with--indeed supportive of--the single monetary policy geared to the maintenance of price stability. This was reflected in the adoption of the Stability and Growth Pact comprising rules and procedures aimed at preventing excessive fiscal deficits in member states and at correcting them in the event they materialized.

It became progressively evident in the mid-2000s and it was painfully demonstrated during the eurozone debt and economic crisis that the economic pillar of EMU was conceptually incomplete and functionally ineffective. It involved a policy framework which did not succeed in fostering and coordinating national economic and fiscal policies so that they would be consistent with the stability-oriented monetary policy of the European Central Bank. Moreover, financial supervision in several member states failed to assess credit, sovereign, and liquidity risks in an adequate and timely manner. Hence, bank balance sheets became...