The eurozone crisis is not yet over and more institutional action is needed beyond the agreement for a banking union reached among top European leaders last year, a senior economist from a leading European think tank said at a recent symposium in Tokyo.
“The crisis still remains very present, even though the immediate tensions have come down,” said Guntram Wolff, deputy director of Bruegel. “The debt overhang remains large, price adjustment is painfully slow, even in the face of major recessions. The institutional response is well under way, but many of the contentious issues are still ahead of us.”
Wolff was speaking during the symposium on the European economy and the eurozone debt crisis, organized by the Keizai Koho Center on Feb. 25.
“Is the banking union enough to end the crisis? My hypothesis is that it will not be enough,” he said. The efforts taken so far, including the European leaders’ go-ahead for a banking union as well as assurances by European Central Bank chief Mario Draghi to do “whatever it takes” to save the common currency, will not be sufficient and the eurozone needs further reforms, including more fiscal integration, Wolff said.
The Draghi statement in July and subsequent actions taken by the ECB to provide liquidity, which followed rising concern earlier in the year over the possibility of Greece’s exit from the euro as well as the banking crisis in Spain, significantly pushed down yield curves on some European government bonds, but the yields “continue to be quite high,” Wolff pointed out.
Financial disintegration within the eurozone that started in 2011 “has only been partially reversed” by the ECB efforts, he said. The correlation between risks in the banking system and sovereign risks, meanwhile, has increased as capital outflows led banks in the eurozone countries to hold even more of their government bond holdings in the bonds issued by their home governments, he noted.
The banking union, which is at the core of the systemic response to the crisis by the European leaders, needs to have three major components, Wolff said.
A basic agreement has been reached on the first component — to establish a common supervisor, rather than national supervisors, responsible for all the banks in the eurozone, he said. The accord among the eurozone leaders to have the ECB take on this responsibility “is a major step toward federalization or integration of eurozone policies,” he said.
On the second component — creating a common institution to actually resolve insolvent banks — Wolff observed that “everybody is quite aware of what it takes and how it should look like, but everybody also says there are still many thorny issues that are not really politically sorted out.”
The third component, he said, is an accord on fiscal burden sharing — who pays the huge bill in case public money is needed to deal with a crisis involving major European banks. “Agreeing now on the use of public resources is difficult and that’s a very thorny issue,” he said.
Wolff said the eurozone countries “need to have some mutualization of those risks” and that without the risk mutualization the banking union will not be completed. While any such regime should not be a full mutualization and national taxpayers should pay up their part, the “catastrophic risks” arising from a banking crisis should be mutualized, he said.
Ultimately, Wolff said the monetary union will need “some form of a fiscal union.” The eurozone needs to have a “fiscal mechanism as a backstop to the financial system,” and that’s why a banking union is not enough to overcome the current crisis, he said. However, reforms on the fiscal aspect of the union do not have the necessary political support at the moment, he said.