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G. Stournaras: Stagnant inflation threatens Europe

The problem with Europe is that it reforms after a crisis has broken out, not proactively. “The Eurogroup, for example, has only very recently been unable to agree either on the creation of a pan-European deposit insurance system, or to complete the banking crisis management framework,” said the governor of the Bank of Greece, Mr. Giannis Stournaras, in a speech of the 22nd Rencontres Économiques, Aix-en-Provence in France.

As he said in his speech, the reason why eurozone member states have so far not agreed to complete the banking union has mainly to do with a basic disagreement: should measures to reduce financial risks come first or come next of these risk sharing measures. “I am not sure that we can afford, either economically, socially or politically, to rely on the same post-crisis reaction mechanisms. A multipolar but partially de-globalized world order dictates that Europe must react in advance and not in retrospect,” he said.

Imperfect union

Referring to market fragmentation, Mr. Stournaras noted that the eurozone is a complete monetary union, but it is still an incomplete fiscal and banking union, as well as an incomplete capital markets union. This imperfection in times of crisis and uncertainty, such as today, due to Russia’s invasion of Ukraine and the ongoing war, creates obstacles (financial fragmentation) in the smooth transmission of monetary policy to all eurozone member states.

Therefore, the time has come, especially now due to the major crisis with Russia’s invasion of Ukraine, for the Eurozone to act proactively. According to Mr. Stournara, the time has come to review the fiscal framework incorporated in the Stability and Growth Pact. The objectives here should be to ensure public debt sustainability for all member states, to achieve countercyclicality in fiscal policy, and to create a central fiscal tool for all euro area member states, activated to deal with symmetric shocks (e.g. pandemic, effects of wars, etc.).

Stagflation

Russia’s invasion of Ukraine has brought the European and global economy to its biggest challenge since the end of the Cold War. Globalization is in retreat. The result is a slowdown in economic growth rates, an increase in prices and interest rates. Winds of stagflation are blowing everywhere, but especially in Europe, which is a large net importer of energy.

Several, including the current German chancellor, have described the Resilience and Development Fund as a “Hamilton moment” for Europe, said Mr. Stournaras, noting, however, that this Fund was created to deal with a temporary crisis, the pandemic . It must be transformed into a permanent mechanism linking fiscal policymaking in the eurozone center to appropriate rules in order to avoid the moral hazard of loosening fiscal stability at national level.

Stability and Growth Pact

“So the time has come to reform the Stability and Growth Pact, which very few now consider to be functional, as well as to complete the missing elements of the Banking Union”, noted Mr. Stournaras and proposed the goals of a new fiscal framework to look forward to:

1. Sustainability of public debt at the national level.

2. Counter-cyclicality of fiscal policy at the national level, so that national authorities can stabilize GDP in times of recession and build up sufficient fiscal reserves in times of growth, thus ensuring sound fiscal management over the economic cycle.

3. Creation of a central fiscal policy tool, turning the Development and Resilience Fund into a permanent fiscal tool, which will finance investments (it will not make transfers, only give loans to avoid the moral hazard of loosening fiscal measures at national level) mainly in the fields of climate change, energy and digital transformation.

New fiscal framework

The main pillars of the new fiscal framework should be:

1. Strengthening the sustainability of public debt at the national level in the spirit of the “six pack” regulation

2. An incentive mechanism at the national level which will have the following three elements: First, a separate (rather than horizontal) rate of public debt reduction for each member country for which public debt reduction is required, taking into account the average refinancing rate of public debt and the natural rate of economic growth. Secondly, a separate (and not horizontal) speed of reduction of the public debt, in order to deal with procyclical effects of fiscal policy. Third, a rule of increasing expenditure, aimed at achieving the specific primary result for each member state.

3. Converting the Development and Resilience Fund into a permanent central tool.

Completion of the Banking Union

The completion of the Banking Union is crucial to the creation of a full economic and monetary union. Otherwise, financial fragmentation will remain active, preventing the smooth transmission of monetary policy and the euro will not be able to compete on equal terms with other international reserve currencies. The basic idea here is that the supervision of banks, their resolution (the banking crisis management framework) and, above all, the creation of a pan-European deposit guarantee system should become pan-European and not rely on national specificities and regulations.

Source: Capital

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