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Research papers to download

Petr Rozmahel, Ladislava Grochová and Marek Litzman, The Effect of Asymmetries in Fiscal Policy Conducts on Business Cycle Correlation in the EU, WWWforEurope Working Paper No. 62, May 2014

Stefan Ederer and Peter Reschenhofer, Macroeconomic Imbalances in the EU, WWWforEurope Working Paper No. 42, September 2013

Renaud Thillaye, Ludek Kouba and Andreas Sachs, Reforming EU Economic Governance: Is 'More' Any Better? WWWforEurope Working Paper No. 57, March 2014

Bas van Aarle, Surveillance and Control of Fiscal Consolidation on a Supranational Level, WWWforEurope Working Paper No. 46, November 2013

How to become an optimal currency area

Europe has elected its new parliament and right now is constituting a new Commission – an apt moment to talk once again about governance in the European Union. The latest research of WWWforEurope on this theme is rather sobering – European institutions exhibit quite a number of shortcomings.

Foremost is the problem that the Monetary Union is still not even nearing an optimal currency union. There is capital mobility of course, but labour markets are still not fully mobile, due to institutional differences and due to non-economic preferences of people. As we all know there is no wage flexibility across the Union and most important, there is no automatic fiscal transfer mechanism. These problems have been aggravated by institutional reforms in the past years following the crisis.

A number of papers deal with these problems and try to give solutions.

In an optimal currency area it is a requirement to have business cycles in different countries attuned to each other. Petr Rozmahel, Ladislava Grochová and Marek Litzman have analysed the European countries in their WWWforEurope Working Paper “The Effect of Asymmetries in Fiscal Policy Conducts on Business Cycle Correlation in the EU”, finding that trade between the same industries in different countries increases this cyclical attuning. On the other side non-membership in the Euro decreases similarity, but most of all fiscal indiscipline hinders and decreases business cycle similarity.

Another problem became evident already quite some time before the crisis: The differences in industry and labour market structures between European countries. The institutional framework does not extenuate these differences but on the contrary increases them, even more so in the wake of the crisis. In their Working Paper “Macroeconomic Imbalances in the EU”, Stefan Ederer and Peter Reschenhofer show that the Stability and Growth Pact as well as the Macroeconomic Imbalances Procedure still work in the direction of increasing macroeconomic imbalances. Both of these mechanisms enhance procyclicality and most importantly, due to the large influence of the real interest rate and the structural differences in production the Southern countries have – under an austerity regime – no chance to turn their current account positive significantly and sustainably. Meanwhile, a decreasing share of labour in national income dampens private consumption even more.

So, what could be done?

Renaud Thillaye, Loudek Kouba and Andreas Sachs propose one method in their Working Paper “Reforming EU Economic Governance: Is ‘More’ Any Better?”: Instead of relying on an all-encompassing (and therefore not very realistic) integration vision for the European Union the authors advise for a more analytical and moderate strategy: When considering whether a specific issue should be coordinated EU-wide, it is advisable to consider different designs for this issue and test them for subsidiarity and implementation effects (including national preferences and moral hazard). In three case studies they show that by refraining from a make-or-break decision one might identify smaller steps which are implementable and could conform to different peoples’ preferences. For example: Instead of EU-wide wage coordination (with the rationale to reduce imbalances) it might yield more results to link developments with productivity and inflation via soft guidance wage. For this it would be important to strengthen the Macroeconomic Dialogue.

A quite unusual approach is taken by Bas van Aarle in his WWWforEurope Working Paper “Surveillance and Control of Fiscal Consolidation on a Supranational Level”: He says that Europe could learn a lesson from nuclear power plants or automated manufacturing systems – both of these are very complex and have to work most reliably in a crisis. The same should be true for European fiscal governance: There is a high degree of complexity and little predictability. Embedding spillovers, stress tests and early warnings to strengthen resilience might prove to be the right way.