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Under
Stress
The global economic crisis is testing
the cohesion of the European Union
Marek Belka
T
HE global financial crisis has jolted Europe’s his- ment, Europe must revisit the frameworks on which it is based,
toric journey toward “an ever closer union.” For because many have been revealed to be flawed or missing.
many years, the great European project progressed Most pressing is the need to overhaul the European Union’s
smoothly, adding new members, eliminating the bar- financial stability framework. This is critical to prevent future
riers that divide its people, and delivering greater prosperity. financial crises and to minimize the costs when they happen.
This crisis is its first major test, revealing framework flaws that Although policymakers have generally reacted swiftly to cri-
the good years had covered up. Although national and regional ses, countries have often pursued different solutions to simi-
responses to the crisis have grown more coordinated over time, lar problems, causing difficulties for others.
it is still too little and too late. Will European institutions and Deposit guarantees are a case in point. Prompted by the
policymakers be able to respond and adapt to keep moving to- crisis, many countries increased their guarantees, with some
ward “more Europe” or will the result be “less Europe,” or in- moving cautiously and others deciding to provide unlimited
deed “many Europes”? The choices made during this crisis will coverage. This distorted competition affected deposit alloca-
shape Europe’s destiny for the foreseeable future. The problems tions and led to cross-border tensions between policymakers—
differ in the west and in the east, but many, indeed the most most important, however, it undermined public confidence
important, challenges must be tackled jointly. in the European crisis response. And although attempts have
been made to address these issues, more needs to be done. For
Financial to-do list instance, the agreement on deposit insurance specifies a mini-
Advanced Europe is experiencing the worst recession since mum level but not a maximum, which would help address
World War II. Decisive and unprecedented policy action has competition issues.
helped prevent an outright meltdown of the financial sector Europe’s regulatory and supervisory frameworks have
and even more brutal consequences for output, but the out- lagged financial market integration. The current framework,
look is still bleak and the eventual recovery will likely be tepid while slowly evolving toward a more European solution, is ill
and fragile. Beyond the immediate need for crisis manage- equipped to adequately anticipate systemic risks. Preventing
Europe’s financial markets from splitting up along national rent account and fiscal deficits, coupled with anemic growth and
boundaries requires “more Europe,” especially in terms of high debt ratios. These countries are now suffering from more
regulating, supervising, and agreements on sharing the costs difficult financing conditions and even worse growth prospects.
of supporting cross-border institutions. This has prompted some analysts to question whether the euro
Another lesson from the crisis is that there is an urgent area can stay together, and others to call for greater “solidarity,”
need to establish Europewide macroprudential oversight to such as issuing euro area bonds for national financing or greater
avoid the kind of boom and bust cycle that is afflicting the federal fiscal powers. These are complex and sensitive issues, but if
global economy now. The recent proposal by the European they are not tackled, they could become highly disruptive.
Commission—based on a report prepared by former IMF Reinvigorated structural reform would ease these strains
Managing Director Jacques de Larosière—would be an and help Europe confront growing social pressures in the wake
important step toward meeting these goals, but much more of the crisis. In the context of the European Union’s Lisbon
is ultimately needed. Agenda for improving competitiveness, Europe has made
More immediately, Europe’s financial system needs to make important progress in liberalizing and opening its markets,
more rapid and better coordinated progress on loss recogni- resulting in increased productivity and employment. But prog-
tion, ring-fencing legacy assets, stress testing, and recapital- ress has slowed in recent years. This is particularly unfortunate,
izing viable institutions while resolving others. Without such because the crisis threatens to undermine future growth by
measures to restore the health of the financial sector, the forcing people out of the labor market and dampening private
macroeconomic effect of the support provided by govern- investment. What is needed is a second generation of struc-
ments and central banks across the region will be stymied. tural reforms to reinvigorate Europe’s economies.
Crises sometimes weaken politicians’ resolve, but they can
Euro area under pressure also be a call to arms and provide an opportunity to over-
The crisis has exacerbated strains within the euro area. Many of come old obstacles. Consider the comprehensive reforms in
the euro area’s 16 member countries have been running large cur- Italy after the 1992–93 Exchange Rate Mechanism (ERM) cri-