EconPol: Flexibility in Monetary Policy and Fiscal Rules Makes European Monetary Union More Resilient to Shocks

The EMU should create monetary and fiscal  mechanisms to safeguard its irreversibility in exceptional situations. This is one of the lessons learned from past crises, as shown in a recent study by the research network EconPol. “The financial crisis and the coronavirus crisis have shown that either monetary policy or fiscal policy, or both, should be aimed at keeping the monetary union together,” the authors argue. Alternatively, member states should include an explicit exit clause in the treaties.

The authors show how such a mechanism could be designed. “We illustrate this concept using a fiscal target zone model: EU member governments are willing to honor the debt stability commitment under existing rules and the no-bailout clause only up to an upper limit of their feasible fiscal effort,” Pompeo Della Posta explains. “Any plan to complete the European Monetary Union should put a central monetary and/or fiscal policy backstop alongside the irreversibility principle,” adds Roberto Tamborini, his co-author. 

A prominent example is NextGenerationEU (NGEU), the authors write. This pandemic plan was developed by the European Commission and adopted by the European Council in July 2020. The plan allocates collective resources to member states and explicitly earmarks them for public spending aimed at stabilizing economies shaken by the pandemic and helping them recover. As such, the plan complements the already enormous expansion of public debt created by national-level contingency plans. From this perspective, the NGEU acts as a backstop to governments’ shock absorption capacity. On the monetary policy side, the asset purchase program and Pandemic Emergency Purchases Program (PEPP) measures planned by the European Central Bank are also useful in emergency situations to preserve the integrity of the EU. The two measures are complements, in that each one allows for less strain on the other.