Essay Schumann Compact 1.3 01

8/13/2019 Essay Schumann Compact 1.3 01

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A SCHUMAN COMPACTFOR THE EURO AREA

byAskoka Mody

BRUEGEL ESSAY AND LECTURE SERIES


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A SCHUMAN CFOR THE EURby

Ashoka Mody


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BRUEGEL ESSAY AND LECTURE SERIESA Schuman Compact for the euro area


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FOREWORD

With this essay, Bruegel scholar Ashoka Mody in

reflect on the direction of, and the approach to, fureuro area. The crisis has moved from a very volaticonsider where we stand and where we want to gthe history of monetary union and shows that Eurohas always stopped short of creating a fiscal uniomonetary union. This has not happened by accidtrary there have been several debates on further policy. But it has always been deferred to later. Sogone further? Mody argues that creating a fiscal uncontrol over fiscal policy and ultimately surrendeignty. Also, in the current crisis, though Europe h

on very significant steps towards more sharing giving up more control to the European level, Euagreed on true risk sharing via fiscal policy. Soachieved through further incremental steps? Mod


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BRUEGEL ESSAY AND LECTURE SER

step. The starting point would be the creation of a resolution authority. This would allow the financily decoupled from national governments, renderiindependent from government solvency risk. Thisestablishment of a true no-bailout clause. Furtherinsurance against major country-specific shocks

euro-area public goods.

Mody agrees that this would be a good solution tocreate a true and deep monetary union. But if Eurotake this step, should Europes policymakers instesmall steps in the hope of eventually arriving at thargues that this could be a dangerous road. It coulcept of sovereignty with ultimate decision-maknational level, while European rules suggest thatcised by Brussels. Can legitimacy of decision msuch a setting? Isnt there a risk that necessary deolution get delayed in the hope of an eventual authority? Certainly, muddling through and mudto each other, as Mody argues. He therefore prCompact, which leverages sovereignty where it pronounced: at the national level. A banking and a

be the start.

I sincerely hope that this essay helps policymakecurrent approach to crisis resolution. Bruegels roth h t f E i t d tl thi id


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A SCHUMAN COMPACT FOR TH

EXECUTIVE SUMMARY

Five years into the crisis, the euro area remains atary union. The emergency measures taken have sfinancial markets have calmed down and the ecappears to be ending. But, especially in the darkcrisis, a grander idea of Europe was visualised. would build stronger economic structures to closeetary union while also achieving greater political is slipping away. A fiscal union with the necessarysizeable European Union budget, predictablEurobonds, common deposit insurance, a fund to tion has been repeatedly deferred with no reapolitical consensus.

The continued incompleteness of the union shou


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Some argue that the current halfway house to apolitical union is a muddling-ahead process. Eurhistory of falling forward, learning from its setBut this view does not account for the hurdle presder of fiscal sovereignty. As the pressure of the crgoal has shifted from an an ever closer union to

That new goal is to reinforce the existing goversupport from technocratic financial fixes.

The difficulty is that the line between muddle thcan be a fine one as delays and half-measures

Whether the concept of a more perfect union isstate, or a prolonged transition to the ultimate goalEurope, the current half-way house creates major

The centralised governance system in its new in

the discredited pre-crisis structure but adds compness. This fuzzy supranationality continues treasonable premise that the member states will ninterest and, indeed, may act contrary to the interestates. But it remains wedded to the questionabltralised oversight provides a corrective. Espesupranationality bypasses the political process, itdiscipline lacks legitimacy. Delays are endemic requires time and member nations have no obligact on their o n Th s irt all no bank res


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A SCHUMAN COMPACT FOR THE EUR

which is assumed to bear some responsibility fPrivate creditors have learned that, except in the tions, they will be protected. The incentives for fuhave been strengthened while the financial resogency mechanisms remain inadequate.

An alternative resting stop on the way to a more pbased on the recognition of ade-facto decentralisatfinancial costs of the crisis have been borne almnational level; that is unlikely to change in the foalternative resting stop would, therefore, seek to m

more robust rather than wish it away. A model wunion that resembles the United States before thThen there was virtually no system of fiscal transdiscipline was enforced by a no-bailout commiteuro area is to leverage sovereign authority wh

national level. This by no means implies giving ution. But it does mean a redirection. By reducing decentralised governance founded on nationaimprove the prospect of a constructive dialogue. decentralised approach requires a Schuman Compacts to voluntarily adopt standards to conduct thand operations. The model of the Fiscal Compact aextend to a compact on enforcement of sovereigand a banking compact. The decentralisation woulfor ard b e ample of leader nations initiati


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THE EUROS FALSE PROM

On 9 May 1950, Robert Schuman, then foreigncalled on Europe to pursue the goal of a federatiurgency of safeguarding world peace, his call was pragmatic. He cautioned that Europewill not be ma

spoke ofconcrete steps to build ade-facto solidarstep was the establishment of the European Coal a(ECSC), which in its pragmatic spirit was a Francopen to the participation of the other countries of Eu

The politics was right. The hunger for peace waincentives for Germany and France were aligned.tics being right, the ECSC dropped the refereInstead, the word community, was applied andguiding vision for Europe. A community has pow

poses common interests and bonds. But it doefederation. So, from the very inception, when advance was most fertile, even the founders werethreshold that compromised core national sovereigfiscal and political authority.

With time, peace was established and the goal ofreceded. In 1970, a group of experts led by Pierre ter of Luxembourg, drafted a blueprint for a EuroWhile the Werner Report proposed a dramatic lea


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(2013) advocates the notion of afederation by expowers jointly exercised by the European CommCouncil, and the European Parliament would be al cases to discipline errant sovereigns. Thus, evenfederal authority would be triggered to censure, support.

The history of the past five years is clear: whenecall to institute a system of fiscal transfers or of opgations to serve the community purpose, the ptraction. That has been the fate of Eurobonds (in

and of all aspects of the banking union that requircommon financial pool.

Some argue that it is only a matter of time before tstructures are established. They see the European

of falling forward to a more integrated union. Efunctional response to overcome the limitations oforward thesis is bolstered by the lingering pEuropean project is moved forward by long-termthan by merely short-term economic objectives. I of falling forward, especially at this critical junground; and, in any case, equating forward movetralisation is incorrect. I make three propositions:

1 The e ro as a political decision b t had no


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even more so, the intrusive post-crisis extensionate the need for Europe-wide fiscal shock absto induce fiscal discipline via centralised survetion. This system acts counter to both the ecoobjectives of the union. The economic costs areity to impose sanctions against fiscal in

innocuous in good times but generates incentigard or for game-playing and deception, whicMore seriously, in periods of crisis, coordinacauses costly delays while diluting the role of mpolitical interests are hurt because the system l

3 More decentralisation can improve economic iof response, and the democratic legitimacy of thcan be achieved by: (a) lightening centralised sating market discipline for sovereigns through

mechanism; and (c) since it is particularly risstruction of a banking union because of inchardest decisions into the future national auencouraged to use their national bank resolutiomatic approaches to close down unviable bank

I argue that the success of this more decentrarequire a Schuman Compact, a set of compamember states would voluntarily adopt standards s r eillance and operations The Fiscal Compact m


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FINESSING FISCAL SOVERE

Peter Kenen argued in 1969 that a monetary unicapability to support member countries experiencturns. This requirement was well accepted in acircles. Yet, neither the Werner nor the (much later

a reference to Kenens advice. This was not a coineignty is the signature symbol of political sovereigappetite to surrender this. Thus, in its design andfirst decade, the monetary union as constructed wthe end point with no path to a more complete un

work has not changed since the onset of the crisihave been used to modify governance structuresmechanisms for emergency response. But becausciously side-stepped the question of political legremain partial and potentially counterproductive

euro was never an instrument for furthering theunion, and, hence, was never a political project3.

Instead, the architects of the euro have consistentthe concept of a fiscal union. The plan was that would exercise the necessary fiscal discipline andfor fiscal support from a centralised fiscal authoriCountries would have sufficient fiscal buffers shocks. To ensure the necessary fiscal discipline, at re as created to monitor and discipline the


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be weak compared with that of the national budgets

management of which will be an essential feature ounion . For this reason, the Werner Report arguedbe useful to have at the national level budgetary and fithat can be handled in accordance with CommunityDelors Report (1989) was more emphatic. It sta

Community Budget was likely to remaina very smspending and much of that would, in any case, cyclical adjustments.

The International Monetary Fund began its serie

lance reports on the euro area in 20034

. None of thereference to afiscal union in the Peter Kenen sreports unquestioningly accept the SGP as the gwork. The 2008 IMF report, produced when downturn in Europe, applauded the monetary u

first decade and expressedgeneral satisfaction withthe SGP as the instrument best suited to dealing downturn (p. 3).

Thus, over nearly four decades, from the 1970 Wonset of the crisis in 2008, there was never a mounion was even considered, much less as a serDecember 2012, the German Bundesbank, in itGerman Federal Constitutional Court on the EurO tright Monetar Transactions (OMT) polic c


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THE CRISIS AS A SPUR?

But perhaps a crisis was needed to force this issuhas arrived. Spolaore (2013) asks if the foundeunion foresaw that its incomplete structure would a crisis and, hence, force a move to a fiscal and

fiscal union buzz reached a high in December 201paralysis of the European banking system anrecessionary economic conditions. While mudeployed in designing a variety of Eurobonds (sand Valhee, 2012, for a summary), there was limi

the revenues needed to support such financing Wolff, 2012). Because the pooling of revenues twas not a realistic prospect, the concept (rightly) dthe absence of a stable revenue-pooling arrangemebe backed by national budgets, either directly or a

ity. This requires that national budgets make refiscal commitments. In the current context, sucments imply a disproportionate reliance on Germbackstop common financial obligations.

The same problem has plagued other similar initito back bank resolution and deposit insurance or titalising banks directly through the European (ESM). Direct bank recapitalisation was promiCo ncil of 28 29 J ne 2012; it has e er since rema


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The ESM itself was a signature achievement of th

ited national obligations to provide liquidity suSimilar to the World Bank, the ESM leveragemember countries to borrow funds from the markorder to stabilise governments and banks. The Ebacked by member state guarantees. Because th

entity that lends to sovereigns, the question arosebailout rule. The German Constitutional Court aCourt of Justice (ECJ) have cooperated in the ESMto the policy objective of maintaining financial sta

Can the ESM be scaled up as a stable and efficienunion? At some point, the German Court will worrments are open-ended and so violate the GeSimilarly, the ECJ will need to determine if at sominjunction against financing other sovereigns is v

the next crisis prompts a scaling up, the expandedwill come with the knowledge that the support is licant concessional element, as this round demonstrated. Will that larger outlay on more copolitically viable? Or requiring, as it does, unanthere be holdouts?

More seriously, the financial stability consequentroubling. ESM-style funding has deepened thha ard in the e ro area Unlike a s stem of a toma


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present value of its repayment obligations, and the

vately-held Irish sovereign bonds fell sharannouncement of this reduced official debt burddebt had been subordinated to private debt. Thussumption in the treaty was turned on its head.de-facto crisis management policy, private credito

their debt will be restructured only in the most extMoreover, the excessive dependence of such a sand risk of sliding credit ratings of other membeinherently unstable financial structure not a deguardian of financial stability.

Ultimately, as Wolff (2012) argues, there is no European budget that allows predictable and aSimilarly, the Van Rompuy Report (2012, p. 12) dthe ESMsshock absorption role and a central

improveoverall economic resilience . At present, tconflated. Debt forgiveness appears to be the onltransfer mechanism because it is opaque; but it isundermines future fiscal discipline and financial s

Wolff (2012) proposes that a European budget eqeuro-area GDP would be a good start in providimparting resilience to distressed economies. Thibe assessed against realistic benchmarks. In respDepression the United States in the 1930s inst


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technocratic fixes can ultimately simulate the esse

budget and banking union, democratic accountabichange. Unless that happens, it is time to move onthe flexibility of their own adjustment processes.

MORE FISCAL DECENTRAL

The starting point of this discussion must be thaeffectively been operating a decentralised systecrisis. The burden of economic adjustment throug

almost entirely on domestic taxpayers. True, therevia the debt relief. But this was not the intent. Lo(and other European funding mechanisms) were intent of avoiding transfers. The money loaneeconomies was to be temporary support to tide th

sumably, a period of temporary stress. In the evean ex-post acknowledgement of the unsustainable

If a transparent system of transfers is not politicallward-looking euro-area economic architecture surthe premise of continued official loans that will evNot only would the economics of such a structuretics rules it out. This is evident in the strategy of drelief in driblets and in the refusal, as yet, to fadebt rite off in the Greek case (Mod 2013b) In


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Thus, if the burden of economic adjustment mus

level, the task is to make thatde-facto decentralisatirobust manner. A way ahead is to mimic the US fiNew Deal8. Then, there was no centralised fiscal stransfers, but there was a credible no-bailout cotion was that it did not provide protection again

such as the Great Depression. But neither doeprospective muddled system in the euro area.nance structure and financial support systems remthree steps are needed:

The delegation of European fiscal governanCommission has long been recognised as counotwithstanding recent initiatives, should be sc

Fiscal policy should be the responsibility of where the sovereignty lies. This concept is al

Fiscal Compact, and is consistent with the prin And, to minimise the risk of excessive future socredible no-bailout regime must ensure that losses when sovereign debt becomes unsustain

The premise since the Werner Report has been thabe trusted to follow prudent fiscal policies, and cewould provide the necessary discipline. That premas is well understood today. The system lackedpeer monitoring created an endemic tendenc for


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plexity that makes them more not less suscep

ciencies. In principle, the enhanced fiscal governsix pack and two pack11) and the macroeconomic dure (MIP) offer a more scientific surveillance frarender decision making more challenging. For exthe SGPs three percent of GDP budget deficit targ

balanced budget deficit is technically appropriatassessment of a countrys potential output, a nebucially during periods of economic stress. The riassessment to be conducted by a committee of mresentatives will be politicised. The actions th

assessment also remain subject to discretion. Recehas been proposed that the remedies be tied to ththe culpable country is implementing structuralSpiegel, 2013). The difficulties are clear. Moreoveincrease central intrusiveness but create no remedly intractable problem of non-compliance. Trichthat ensuring compliance remains a largely unreswill require surrender of national fiscal sovereign

Draghi (2013), faced with this dilemma, has propobe redefined. The prerogative of nationally-electeon behalf of their citizens is an anachronistic viesays; instead (p. 2),sovereignty relates to the abilitytice the essential services people expect from govep t this is a restatement of the premise that na


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Thus, as anxieties and stresses have increase

European institutions are bearing the brunt of the bpublic debate with the German chancellor, Angeprime minister, Donald Tusk, expressed the fear delegated to Europe would be dominated by the lathat other national leaders no doubt harbour (Trayn

is not a propitious moment to push for pooling of

CENTRALISATION AND SOVE

Central surveillance and regulatory norms on soveoperational challenges of the euro area. Before tpolicy was no bailout. The markets may havewould be a bailout, but the crisis confirmed that thWell before the financial responses to the crisis chazard problem, the euro areas fuzzy governanceseeds of the problem. Tirole (2012, p. 228) stahave imposed no discipline on each other and mathought that their lending to weak sovereigns wouldMore forcefully, von Hagen and Eichengreen warned that the system...will increase the pressurundermine Brussels capacity to resist . That percbeen proved wrong and a precedent could have benforcing the no-bailout principle as this crisis upolic of official f nds to repa pri ate debt in a


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Draghi (2013) has stipulated that the centralised

ture should seek to maintain sovereign debt as asaf

A careful consideration of the sanctity of sovereigthe broader debate on the future architecture ofmember states have given up the flexibility of thei

and, lacking a centrally-funded fiscal capacityrequire the buffer of sovereign debt restructuringdence in a country might have triggered speculatexchange rate, the focus of the speculation will nprice of sovereign debt (see Mody, 2013a, for a di

Committing to sovereign debt as risk-free also hations for banks. Banks have a strong incentivregulatory model to increase their holdings of thereby reduce their capital requirements. Systemed through two different channels. Caprio (2013several banks increase their exposure to the samance of bank risk increases. Moreover, the correlatfaced by sovereigns and banks, which proved soheight of the crisis, is strengthened. The policy efereign-bank link is best served by regulatory recodebt risk rather than through the indirect and method effort of freeing the sovereign of the obligdomestic banks. The implication also is that thq alit re ie and stress tests of banks ill need


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default (Mody, 2013a). For over 150 years, state an

ments in the United States have repeatedly defastate governments defaulted in the 1840s and, thenernments took on more fiscal responsibility, th1870s and in the 1930s (Inman, 2003). Although,height of the Great Depression led to a major expa

authority to provide fiscal transfers, the principlegovernments has continued. The state of Arkansaand municipalities have continued to do so to the

Some are concerned that a no-bailout commitm

maintain. The US experience is unusual and because in a crunch; the perception of contagiondamage will crystalise the policy incentives in favvate creditors (Rodden, 2006). That risk is inBuchheitet al (2013) propose measures for orderlydures for sovereigns. Their proposal remains the moving ahead; the difficulty is that, in the past, salleviated the concerns about contagion and, constendency to defer restructuring has remained endeof a sovereign bankruptcy court, with a record forestructuring, default on debt must be built into d2013a). One approach would be for debt contractsbeyond certain thresholds of debt ratios or risk spallow for pre-emptive debt relief in an automamanner Indi id al so ereigns ill pa higher in


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Decentralisation (although not risk free) offers a w

dard arguments in favour of decentralisation are thlocal needs of residents, creates opportunities forfosters yardstick competition, whereby innovaticreate peer pressure on laggard governments (Barbenefits of decentralisation increase with the h

needs and preferences of local residents15

.

But there is a deeper basis for decentralisationmaintaining national sovereignty. Drawing the linity between levels of government is primarily a

discussing the practice of subsidiarity in the EuBremann (1994, p. 5) says:Ones judgment about wcomports with the principle of subsidiarity is a prone . Similarly, Inman (2003, p. 56) says that thhas been unable to define valid policy domains governments because of limited constitutional gunational context, except when they seek externagovernments zealously guard their fiscal indepetouchstone of their political independence. The crplaced the burden of fiscal adjustment at the nachange can be expected in the future. National requires and can foster a more mature relationshipWithout distance from European institutions, deremain prone to all the problems witnessed during



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up incomplete and inefficient arrangements, relying

mistic expectation that such inefficiencies can alwaysa later stage through additional integration . Thesethe context of half-way house fiscal integration, substantial.

National fiscal sovereignty can be based on comrules, and the Fiscal Compact provides the way fothe two/six packs, which were secondary legislaTreaties as legal basis, the Fiscal Compact is aagreement (in which EU institutions other than

role). By signing the Fiscal Compact, some EU mvoluntarily to a number of common objectives (turally-balanced budget rule). Almost all 25 oUnion members have signed17. But the interpretatiotion of the fiscal rule is then left to the member that fiscal indiscipline will arise can best be cobailout commitment. Under a Sovereign Debt Cwould agree to issue debt only with contractual crestructuring. An intergovernmental agreement to will do more for fiscal discipline than more sophi

DEALING WITH THE BAN

The banking sector contin es to bear the deepest



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easy liquidity from the ECB. Stress tests and asse

tional capital needed by banks were quickly, and not credible.

Any forward movement is stymied by a focus on financing a prospective banking union. Common

deposit insurance funds require member countriecommitments to a common resource pool; that, inwhether countries are willing to cede some authoral budgets. German finance minister Schuble hastep is inconsistent with existing treaties (Schu

political willingness to attempt treaty change is vital for progress on these initiatives to be madehave shied away from seeking a political mandateof the needed fiscal backstop of a banking unionward movement can only occur through the poundesirable and increasingly remote prospect.

In the meantime, with continued regulatory forbeaJapanese experience of zombie banks becomes mby zombie banks to zombie firms undermined Jagrowth (by propping up the zombie borrowers azombie competitors); these productivity woes undermine the banks (see for example Hoshi anWith borrowers stress still high in most euro-threats to financial stabilit and gro th contin



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cles to reforming the German and French bankin

nations did undermine the SGP.

Moreover, experts including ECB officials areunder the visualised banking union framework, thanism risks being toothless without a properly

authority. But the resolution funding requires a levsupport that is politically impractical. These conunthe mild-mannered IMF to warn ofthe pitfalls of a pieand an outcome that is worse than at the start anmissing elements would result in an incoherent bank

worst, an architecture that is inferior to the current natTranslation: beware the muddle.

A new approach is needed. Tackling the here-andbe the priority. This requires moving ahead with bank resolution while minimising the needs fthrough aggressive use of well-understood and pdebt-to-equity swaps (see Veroseni and Zingales,rowers will need debt relief (through personal insobankruptcy procedures) and, while small depositoed, creditors will need to bear losses. The continuesensitive matters remains the Achilles heel of thprocess. For sure, the allocation of losses requirebut wishing away this challenge will not make it dthe transition to a sec re deposit ins rance s stem



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illed interbank transactions and, in doing so, pra

emerge. Following the onset of the crisis, several resolution authority to their crisis management tolution has been rare. The contrast with the Unitedthe US, large numbers of small and medium-sizedmerged between 2008 and 2010, while larger ban

ly restructured. The crisis experience, even in Eucan be done.

In this light, the recent German proposal for a baning (Schuble, 2013). It is a small but sensibl

direction. Under the proposal, member countrieenforce, common standards on bank resolution anIn principle, this approach lends itself to another Compact. A voluntary intergovernmental agreemdards for countries to act but leave them the optioexperimenting with novel approaches, allowingthrough peer pressure, of truly rigorous benchmhealth and disciplining powers.

The German proposal offers a practical way aheadleads by example. If Germany is to lead, it must ato its own troubled banks and shed its reputationgeneration of international bank regulatory standmultiple deposit-insurance systems, none of whicstandards of best practice Long j stified b the e



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agenda on protecting the banking sector from futu

Beyond the immediate, a bigger agenda beckons Econcern remains that despite the efforts to learn steps to strengthen regulation remain inadequate is more so in the euro area than in any other majo

tion. The forbearance on account of the fundinpreoccupation with establishing complex (and, hnance structures and funding mechanisms have saway from a more fundamental discussion of baneuro area seems to be doubling down on an incr

Basel III process. The allegiance to the philoso(and assigning zero risk weights to sovereiunchanged. Indeed, the European particularly thon Basel III capital-requirements negotiations hasdards and go slower (Goldstein, 2012). In the meaSwitzerland, have moved ahead with greater emphage ratios and convertible debt instruments. Thmust feed into the strategy for reshaping the esystem.

A WAY OUT OF THE IMPASSE: A S

Europe may eventually back into a political uniomonetar nion More likel that ill pro e to



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has increased. These are creating their own anoma

plexity and intrusiveness, the technical advances deepened the traditional incentives for delays andwithout political legitimacy, the enforcement and dremains unchanged. The emergency financial meathe free fall. But in their reversal of no bailout, th

moral hazard risk, with a heightened threat instability.

A technocratic vision of Europe muddling aheadpolitically dangerous. The economics is wrong bec

and financial sticking plasters tend to come unstfester. Uncertainty persists, the trust in institutionsprospects are hurt. The politics is wrong because tiative are understated and the surprise deepens time, for many, the sense of economic and pbecomes more entrenched. In the absence of a leshrill and nationalistic voices gain ground.

The simple truth is that all crucial decisions that ring are being pushed back. No progress has been athe EU budget; instead, there is pressure to scalfinessing the overall budget limitation by changingunion presumes that governments will be willresources to a common pool if the funds are designbanking stabilit B t that pres mption has fo nd



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decision makers into dangerous inaction. The

(2013), for example, have put forward an assessmsimilar to the one I have outlined, and their warnin

None of the fundamental problems underlyinghave been solved not the banking crisis, nor the

crisis, nor the competitiveness crisis. National debttinue to escalate. Banks are overloaded with bad loa private sector. In the crisis countries, a generation isof their livelihoods and opportunities. The marginspectrum in these countries are becoming increasing

And willingness to find common solutions for the eto be rapidly on the wane. We eleven German econand political scientists cannot accept the prospect ing for time and betting with ever-larger wagers will eventually pass.

The Glienicker Gruppe calls for far-reaching econgration, achieved through a new Euro Treaty. Gvoice in the future of Europe, and the eleven econothe lead. Germans, they say, must recognise that good for Germany, and their appeal is to the Germship to move forward with urgency. A bold step galvanise action.

A ell f nctioning fiscal nion ill itho t q



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Europe. The present strategy, viewed sometimes

could devolve into a muddle. The alternative restincated in this paper, transfers fiscal responsibiliauthorities. Such a decentralised approach disrupthe European integration project to initiate a newThe intergovernmental compacts proposed would

but by recognising national governance authoricounterproductive efforts to manage fiscal and finly and create space for the evolution of solidarity.

Importantly, a decentralised approach would allowof economic adjustment to proceed. For the euro anomic objective must be to deleverage. Sovincentives to borrow less and the banking sector The implication also is that country differences in be allowed to emerge. Much of the guiding philososovereign debt risk-free and to reduce differencescosts in different countries recreates the problcrisis. Under a decentralised process, member stawill either stabilise or renegotiate with their crediemerges will be in a stronger position to considfiscal union and such frills as Eurobonds. The tranBut the present approach is inclined to push thefuture and rely on the elixir of growth; the risk is choices ahead will become ever harder.



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is stymied by fiscal and governance problems. A

stop would provide an opportunity to reset, reflecourse toward a more stable, more integrated Eurothe time and space to choose more Europe wouvalues that have guided integration for moreContinuing to stumble forward could lead to a debi



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SC U CO C O U


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NOTES

1 For many conversations and comments, the authorBordo, Kevin Cardiff, Barry Eichengreen, EdwaPatrick Honohan, Otmar Issing, Peter Lindseth, BenORourke and Tobias Troger. Michael Leigh and Gon several drafts and to them I am especially gratef

that our perspectives continue to differ.2 http://europa.eu/about-eu/basic-information/symbolday/schuman-declaration/.

3 To be sure, the euro was linked with the pursChancellor Helmut Kohl and French President Franmonetary union the political gravitas for moving fKohl famously made the connection between thpeace. But this was no more than a poetic flight of ular, has repeatedly walked away from moves towEurope.

4 The IMFs Articles of Agreement require regular sions with each member country on the countrys ecpolicies. The report from these discussions is calleThe concept of a report for the group of member coeuro area was an innovation.

5 Emphasis added. The English translation is fromhttp://www.antehoc.com/2013/06/bundesbank-letter

6 http://register.consilium.europa.eu/pdf/en/08/st06/stre07.en08.pdf.

7 https://mninews.marketnews.com/content/regling-estop-srm-without-treaty-change,http://www.irishtimes.com/business/sectors/financies/sch%C3%A4uble-pours-cold-water-over-idea-of



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9 Alesina and Perotti (2004) propose that the Commtank, akin to the OECD.

10 Even the IMF, a neutral agency with no skin in tits surveillance of the euro area, say Pisani-Ferryet al

11 For background information on EU economic gohttp://ec.europa.eu/economy_finance/articles/go14_six_pack_en.htm.

12 In Ireland and Spain, national and European instituvery large but similar-sized loss of trust.

13 The principle of imposing losses on bank creditoaccepted, but the content and timing of its applicatIn making the bail-in decision, the announcementtion authorities would also have the power to exclude, liabilities on a discretionary basis for the following reaexception includes the ever present threahttp://www.consilium.europa.eu/uedocs/cms_data/dfin/137627.pdf. The ECB and the European Commare engaged on a debate on the applicatiohttp://www.bloomberg.com/news/2013-10-20/drbank-aid-rules-over-forced-losses.html.

14 Such convertible debt (cocos) contracts are being ito replenish capital when their capital is running low(2013) recommend that the trigger for conversionprice. In the sovereign cocos context, this couldextension of debt repayment maturity when the 90-the ratio of the market value of debt to its face valucentile of the distribution of this ratio in the past fiv

15 See Alesina, Angeloni, and Schuknecht (2002) for aate decentralisation in Europe.

16 Formally, the Fiscal Compact is the Treaty on Sta


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ABOUT BRUEGEL

Bruegel is a European think tank devoted to internstarted operations in Brussels in 2005 as a Belgian nal organisation supported by European governcorporations. Bruegel seeks to contribute to the quacymaking in Europe through open, facts-based research, analysis and discussion.

Bruegel issues a range of publications. Bruegel Policyse, topical analysis targeted at an audience of exdecision-makers, with an emphasis on concrete polic

Policy Contributions are responses to requests by pobodies, including testimonies at hearings or responsetion. Bruegel and its researchers also publish worcollaborative papers with other organisations, and Essay and Lecture Series provides a compact recordlars and practitioners as they write for, or lecture Schuman Compact for the euro area is the seventh Bruegel Essay and Lecture Series.


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33, rue de la Charit, Box 4, 1210 Brussels, Belgiumwww.bruegel.org

A SCHUMAN COMPACT FOR THE EURO ARE

byAshoka Mody

Although it has been put forward as an ultimate antidote to the crisis, aEuropean fiscal union with the necessary financial buffers has been repeated-ly deferred with no realistic prospect of a political consensus. This should not

be a surprise. The euro area has run into a fundamental barrier. The next stepto a conventionally-complete monetary union requires the surrender of national fiscal sovereignty and, hence, of political sovereignty to achievean effective federation.

A realistic alternative would be to seek to make decentralisation more robustrather than wish it away. The task for the euro area is to leverage sovereignauthority where it exists: at the national level. A model would be a monetaryunion that resembles the United States before the Great Depression. This by

no means implies giving up the goal of an ever-closer Union but it does meana redirection. To succeed, this more decentralised approach requires aSchuman Compact, a set of compacts through which EU member states vol-untarily adopt standards to conduct their own surveillance and operations onenforcement of sovereign debt restructuring and a banking compact. Theurgent task of bank resolution would be an ideal test case. Such experimentalsteps would create real forward motion and also foster, as Robert Schumansaid in his iconic declaration, ade-facto solidarity .

ASHOKA MODY is Charles and Marie Robertson Visiting Professor of International Economic Policy, The Woodrow Wilson School, PrincetonUniversity and Non-Resident Fellow, Bruegel.

109 789078 910336

ISBN 978-90-78910-33-6

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