The beneficial effects of the crisis on the euro
Governor of Eesti Pank
It is vitally important for Estonia that the European monetary system is in good health. Although we are still very new to the system, the Estonian public seems to understand well what it means.
This is not surprising. History has taught us that if the European monetary system is weak, so is international trade. When trade in Europe slows, all businesses find it harder to sell their products, and if Estonian businesses have problems selling their goods, the Estonian people will have less work and less money. So it is only logical that as we join the euro area, Estonians want to be sure that the European monetary system is working as well as possible.
For the most part, the euro has been a success
In general, the euro has proved successful. Average inflation in the euro area has remained low, and the strong legal foundation that has guaranteed the central bank system the independence necessary to fulfil monetary policy goals has given people in Europe confidence that price rises will remain under control in the future. Inflation in the euro area for the next few years is estimated at 1.4-2.2% and the stabilisation of inflation expectations has been an excellent result given global price pressures.
As the inflation risk is seen as being low, the overall capital price has also remained favourable. In the euro area, the average interest on business loans with maturities of over five years is only 3.4%. The markets trust the monetary policy of the European Central Bank. There is no doubt that without the monetary union, European countries would have struggled more with the negative impacts of the financial crisis. In this sense, the monetary union is effective and has justified itself completely.
The euro has also proved a success in several other ways. Nobody would deny that during the past ten years the performance of financial transactions has improved and comparing prices in Europe has become easier than ever before. This would not have been possible without the single currency and we should not underestimate the role of the currency in these developments.
Tactical challenges for the euro area
At the same time, it is right to say that there are many things wrong with the European monetary system. For a start, there are too many European countries that have not joined the monetary union yet. While some are making an effort to get there, others have decided not to join the euro area because of political aversion to it, and yet others are finding that the process of becoming a member takes too long because they have excessive fiscal deficits or insufficient economic flexibility.
This is not good for us or for them. The flow of goods is smaller, there is less market pressure on prices and our continent is not able to reach its full economic potential. Businesses must always be prepared for unexpected shocks from currencies outside the European Union, and although the single currency cannot and does not have to solve all the problems of the European economy, the Economic and Monetary Union has helped to save resources. This is extremely important for business given how fierce global competition now is.
Currently however, the uncertain financial situation in some euro area countries is a greater problem than the limited size of the euro area. The problem is not that the euro area rules are not sufficient for the smooth operation of the single currency, it is rather that some countries did not adhere to the euro area rules during the good times and some even had inaccurate data.
The problem is not the financial sums risked by their failure. The financial system of the United States works efficiently even if some states or local governments have trouble servicing their loans, and this shows that a monetary union can remain operable even if there are solvency problems in a few member countries. It becomes a problem when there is no clear answer to how these countries plan to act in a solvency crisis, whether the mistakes will be corrected or will lead to increasing conflicts in the whole of the monetary union.
The crisis as a test of strength
Although the gravity of the situation must not be underestimated, it is by now clear that the problems that surged to the fore in the euro area during the crisis have not brought us even close to what the euro sceptics almost publicly hoped for - the dissolution of the euro area. On the contrary, the reaction of the member countries both independently and together has proved that the desire to keep the single European currency is much stronger than the temporary problems the currency encountered.
Those who cultivate such hopes have a very distorted view of the importance of the single currency for the European economy. The benefits of the euro are popularly seen in terms of how much money one country can lure from another under the cover of the monetary union, but from a broader perspective however, this is almost irrelevant.
The single currency is important to Europeans primarily because the whole region's monetary policy aims for long-term stability and because the single market is supported by one stable currency, which acts as a landmark and facilitates economic activity. These key needs in Europe are entirely ignored by those sceptics who talk only of the fiscal problems. Indeed it is true that a less trustworthy country may temporarily gain more from the monetary union, but in the long-run the financial aid that it receives is really of secondary importance.
As the crisis abates, confidence has grown in the unwavering strength of political support for the monetary union during difficult times. This support, which had so far barely been tested, provides a link in the monetary union that has passed its first test surprisingly well. In some ways the Eurosystem is even stronger than it was before the crisis, as the insecurity caused by the crisis has already partially disappeared. As confidence grows in consequence, the next key task is to continue work to eliminate the bottlenecks that the crisis identified.
Correction of mistakes
The crisis is thus also an opportunity for the monetary union. It means that we can make the system more efficient, and so increase confidence in the monetary union. This is a very familiar situation for us given the problems we have experienced in our homeland. As I mentioned at the beginning, the euro area requires no major changes, it is rather a question of updating existing rules in three different areas, and due to the political structure of Europe the most important of these areas is not the part of the financial system that deals with solving problems, but the part that helps prevent them from arising at all in the future.
An agreement was reached on the conditions under which financial aid will be given to Members States that have encountered difficulties. There is no question that billions of euros will be simply handed over to anyone who asks nicely, loans will rather be given only in exchange for guarantees of a strict long-term plan for a policy of economic rehabilitation. It must be emphasised that the agreement has a fixed term and that further decisions will need to be taken in the next few years to set permanent solutions in place.
It is also now evident that it is more important to harmonise economic policies during normal times than to concentrate on regulations for financial aid. This will not require a miracle. In order for the monetary system to operate smoothly, we need to improve the unexciting functional rules that demand that European budgets be balanced within a reasonable time, rather than focusing on the dramatic and exciting financial aid funds. Non-specialists are only interested in the monetary system during crises, so an efficient monetary system should appear boringly stable to the non-specialist.
Finally, although the rules are very important, we need stronger sanctions for failure to implement them. This is a contradictory and difficult area, but some progress has even so been made, and the crisis itself has partly aided the situation. While sceptics may consider the crisis a wholly negative event, it has given an impetus to efforts to solve old problems. No European country believes any longer that full adherence to fiscal rules is unimportant. Several countries have adopted measures that no rule or threat of sanction could have made them adopt a year ago.
The Eurosystem is stronger than last year
The risks endangering the smooth operation of the monetary union were already well-known before the crisis. During preparations for monetary union and throughout the past decade it became evident that no one knew how the monetary union would react if there was a loss of trust in a particular country. Matters were aggravated by the fact that financial markets, which panicked about possible insolvency of some countries this year, quite recently still presumed that the problem would be solved somehow and the struggling countries would be helped out. Unfortunately, this led to the general assumption that countries with stronger and weaker financial positions could be assigned the same level of risk, and this was, of course, a mistake.
It is inappropriate to point to some Mediterranean Member States alone. They may have been the main targets of market speculation and have high public debt, but other countries should also have taken different decisions during the good times. This also applies to our region.
The importance of the monetary union for the European economy currently seems much greater than temporary financial difficulties. The problems that arose have not weakened the fiscal rules but have forced us to deal with the issues more seriously. In conclusion, it seems clear that next year Estonia will be joining a stronger monetary union than it would have done three years ago.
Published in Postimees, 18 August 2010