Europe Under Stress
| Author | Marek Belka |
| Position | Director of the IMF’s European Department |
| Pages | 8-11 |
Page 8
The global economic crisis is testing the cohesion of the European Union
THE global financial crisis has jolted Europe’s historic journey toward “an ever closer union.” For many years, the great European project progressed smoothly, adding new members, eliminating the barriers that divide its people, and delivering greater prosperity. This crisis is its first major test, revealing framework flaaws that the good years had covered up. Although national and regional responses to the crisis have grown more coordinated over time, it is still too little and too late. Will European institutions and policymakers be able to respond and adapt to keep moving toward “more Europe” or will the result be “less Europe,” or indeed “many Europes”? The choices made during this crisis will shape Europe’s destiny for the foreseeable future. The problems differ in the west and in the east, but many, indeed the most important, challenges must be tackled jointly.
Advanced Europe is experiencing the worst recession since World War II. Decisive and unprecedented policy action has helped prevent an outright meltdown of the financial sector and even more brutal consequences for output, but the outlook is still bleak and the eventual recovery will likely be tepid and fragile. Beyond the immediate need for crisis management, Europe must revisit the frameworks on which it is based, because many have been revealed to be flawed or missing.
Most pressing is the need to overhaul the European Union’s financial stability framework. This is critical to prevent future financial crises and to minimize the costs when they happen. Although policymakers have generally reacted swiftly to crises, countries have often pursued different solutions to similar problems, causing difficulties for others.
Deposit guarantees are a case in point. Prompted by the crisis, many countries increased their guarantees, with some moving cautiously and others deciding to provide unlimited coverage. This distorted competition affected deposit allocations and led to cross-border tensions between policymakers— most important, however, it undermined public confidence in the European crisis response. And although attempts have been made to address these issues, more needs to be done. For instance, the agreement on deposit insurance specifies a minimum level but not a maximum, which would help address competition issues.
Europe’s regulatory and supervisory frameworks have lagged financial market integration. The current framework, while slowly evolving toward a more European solution, is ill equipped to adequately anticipate systemic risks. PreventingPage 9 Europe’s financial markets from splitting up along national boundaries requires “more Europe,” especially in terms of regulating, supervising, and agreements on sharing the costs of supporting cross-border institutions.
Another lesson from the crisis is that there is an urgent need to establish Europewide macroprudential oversight to avoid the kind of boom and bust cycle that is afflicting the global economy now. The recent proposal by the European Commission—based on a report prepared by former IMF Managing Director Jacques de Larosière—would be an important step toward meeting these goals, but much more is ultimately needed.
More immediately, Europe’s financial system needs to make more rapid and better coordinated progress on loss recognition, ring-fencing legacy assets, stress testing, and recapitalizing viable institutions while resolving others. Without such measures to restore the health of the financial sector, the macroeconomic effect of the support provided by governments and central banks across the region will be stymied.
The crisis has exacerbated strains within the euro area...
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