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WEATHERING THESTORM
Fair-weather versus stormy-weather governance in theeuro area
JEAN PISANI-FERRY AND ANDRÉ SAPIR
Highlights
•The euro is and will remain a stateless currency. Treatyrevisions and failed referendums have buried the idea thatit is a stepping stone towards European political union. Thishas consequences for the euro’s governance structure.•The complex governance structure of the euro area wasdeveloped on the assumption that prevention would makecrisis management provisions unnecessary. Thisassumption is now being tested.•The experience of the crisis shows that the euro-areagovernance system lacks some crucial properties: speed of reaction, policy discretion and centralised decision-making.These shortcomings have damaged the euro’s internationalstatus because a question mark has been raised over itseffectiveness as a stormy-weather currency.•The euro has proved attractive as a fair-weather currencyfor countries and investors well beyond its borders. But itstill remains to be seen if its governance is strong enoughfor it to succeed as a stormy-weather currency.Prepared for the Bruegel/Peterson Institute volume
The euro at10: the next global currency?
, edited by Jean Pisani-Ferry andAdam Posen, forthcoming April 2009
    B    R    U    E    G    E    L    P    O    L    I    C    Y    C    O    N    T    R    I    B    U    T    I    O    N 
    2    0    0    9    /    0    3
MARCH 2009
 
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Weathering the storm: fair-weather versus stormy-weather governance in the euro area
Jean Pisani-Ferry and André Sapir
1
March 2009
The euro has been, is and will remain a currency without astate. Ten or even five years ago many in Europe would havequestioned this assertion, because they saw the single cur-rency as a stepping stone towards political union. A fewtreaty revisions and failed referendums later, however, thisperspective has vanished. Even if the Treaty of Lisbon, whichincludes most of the provisions of the aborted constitutionaltreaty, is eventually ratified, the momentum has been lost.For all practical purposes the euro must be regarded as anorphan currency.The governance structure that results from this situation is acomplex one. The choices made at the time of the MaastrichtTreaty – a monetary union without a significant federalbudget, limited coordination of budgetary and structural poli-cies, no integrated financial supervision, no strong politicalcounterpart to the central bank – were regarded by many of its architects as temporary. Over time, it was hoped, a morefederal governance structure would emerge. The main play-ers in the negotiation, Germany and France, did not have thesame views on what this structure would be, but they sharedthe same dream: both expected the euro to accelerateintegration.Reforms of limited ambition are still possible and desirablebut on the whole the euro is bound to live with thisgovernance structure in the years to come. This does notmean that it is doomed to fail. In fact it has thrived in its firstten years of existence. The euro has provided price stabilityto previously inflation-prone countries. It has offered a shel-ter against currency crises. It has by and large been con-ducive to budgetary discipline. It has attracted five newmembers in addition to the eleven initial ones. And manycountries in Europe wish to adopt it .On the world scene, the euro has also been successful. Eventhough research presented in this volume confirms that ithas not rivaled the dollar’s world currency status, it has cer-tainly become a strong regional currency in Europe and theMediterranean region. Some countries in the region have
de facto
adopted it, several peg to it, and many have become atleast partially ‘euroised’
2
.The question we address in this paper is whether thegovernance structure of the euro area is a handicap to fur-ther gains in its international role and influence. Is the in-complete character of European integration bound to beperceived as a lingering weakness? Or is the rest of the worldlikely to accept, and adapt to, the
sui generis
character of theEuropean currency?This could have remained an abstract and unsolvable ques-tion. In fact, while governance had long been a topic for dis-cussion among European scholars and policymakers, the restof the world understandably paid limited attention to it. How-ever, the advent of the crisis has put European governance toan unexpectedly severe test. While the euro was introduced inthe midst of the ‘great moderation’ period and benefited fromit in the first eight-and-a-half years of its existence, the fol-lowing 12 months were more agitated and the last six monthsof its first decade were especially stormy. What this limitedexperience has shown is that there is a sharp contrast be-tween what can be expected from a governance system infair-weather conditions and in stormy-weather conditions. Atthe time of writing (early 2009), several lessons from this ex-perience can be drawn already. Many more will certainlycome.To address this question, we start in section one by briefly lay-ing out our conceptual framework. Section two is devoted toassessing the euro area’s fair-weather record. Stormy-weathergovernance is reviewed in section three. We draw lessons forgovernance in section four and conclude in section five on theimplications for the international role of the euro.
1.Accounts of the first ten years of the euro can be found in European Commission (2008) and Pisani-Ferry
et al
(2008).2.See especially György Szapary’s contribution to
The Next Global Currency?
(Pisani-Ferry and Posen, 2009).
 
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1. Conceptual framework
Citizens generally do not expect their political leaders to ex-hibit the same qualities when the country is in peace andwhen it is at war. Similarly, one does not expect the samefrom economic governance in normal and in crisis times.In normal times key properties are stability, predictabilityand incentive compatibility:•After the damage of inflation and the stop-go policies of the 1970s, the vast majority of countries in the world haveconverged on policy regimes that give high priority tomacroeconomic stability. Clarity of objectives and trans-parent matching between policy objectives and policy in-struments, including by assigning price stability to anindependent central bank, have proved to be key tech-niques in this respect.•In a world of forward-looking expectations, the pre-dictability of the policy course and of its responses toshocks has become regarded as an essential property.Policy rules that inform the public about the policymak-ers’ reaction function have gained increasing support, ei-ther in the primitive form of instrument rules or in moresophisticated forms such as flexible inflation targeting.•Finally, incentive properties are of major importance in asystem like the European one that relies heavily on de-centralisation. With monetary policy centralised but budg-etary and structural policies decided upon at nationallevel, it is important that actions taken at one level inte-grate with those taken at another level in a way that isconsistent with the overall objective. Especially, a keyissue is whether or not actions taken centrally create in-centives for stability-oriented actions by decentralisedplayers. For example, important questions are whether thesystem is able to make budgetary policies consistent withthe overall goal of price stability and whether labour andproduct market reforms introduced at national level areconducive to swift adjustment in response to shocks.However, different properties are needed in crisis times.Stability remains the objective in the medium term but, in theshort term, speed in countering the effects of the crisis israther the overriding goal. Instead of predictability, policy-makers seek maximum discretion to address problems asthey emerge and freedom to adopt innovative, previouslyuntested solutions if needed. Finally, centralisation with aview to ensuring swift implementation takes precedence overincentives for good behaviour at decentralised level. Hencethe qualities that are expected from a policy system in crisistimes are clearly different from, and to some extent evencontradictory to, those expected from the same system innormal times.A telling illustration of this tension is provided by fiscal andmonetary policy. In normal times the consensus view amongeconomists is that the two instruments should be managedseparately and that interaction between the two should beminimised. But in crisis times there can be a need forconsiderable interaction between monetary and budgetarypolicies.Criteria for assessing the performance of the euro area there-fore need to be specific to the situation. Instead of analysingperformance in normal times and assuming that this recordis indicative of the performance across the entire distribu-tion of probable events, we draw a sharp distinction betweenthe two types of situation and analyse performanceaccordingly.
2. The fair-weather record
The record of the euro area was extensively assessed on theoccasion of the tenth anniversary of the common Europeancurrency (see especially European Commission, 2008 andPisani-Ferry
et al
, 2008, on which this section draws).It is widely agreed that the transition to the euro was re-markably smooth and that, in spite of the disparity of the par-ticipating countries’ previous inflation records, price stabilityhas on the whole been achieved. Figure 1, showing for the USand the euro area the break-even measure of inflation ex-pectations, indicates that they have remained low and stableover the 2004-2008 period, including during the 2008 com-modities-induced price hike. This has been a major contri-bution to macroeconomic stability.
       3       1       /       0       3       /       0       4       3       1       /       0       5       /       0       4       3       1       /       0       7       /       0       4       3       0       /       0       9       /       0       4       3       0       /       1       1       /       0       4       3       1       /       0       1       /       0       5       3       1       /       0       3       /       0       5       3       1       /       0       5       /       0       5       3       1       /       0       7       /       0       5       3       0       /       0       9       /       0       5       3       0       /       1       1       /       0       5       3       1       /       0       1       /       0       6       3       1       /       0       3       /       0       6       3       1       /       0       5       /       0       6       3       1       /       0       7       /       0       6       3       0       /       0       9       /       0       6       3       0       /       1       1       /       0       6       3       1       /       0       1       /       0       7       3       1       /       0       3       /       0       7       3       1       /       0       5       /       0       7       3       1       /       0       7       /       0       7       3       0       /       0       9       /       0       7       3       0       /       1       1       /       0       7       3       1       /       0       1       /       0       8       3       1       /       0       3       /       0       8       3       1       /       0       5       /       0       8       3       1       /       0       7       /       0       8
1.82.02.22.42.62.83.0
USEuro area
Figure 1:Inflation expectations in the US and the euro area
(three-month moving average of monthly break-even rates)
Source: BIS, Bruegel calculations
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