In the NZZ (August 7, 2015), René Höltschi provides an excellent overview over the status of European Monetary Union (EMU).

Issues:

• EMU combines centralized monetary policy authority with decentralized fiscal powers. This creates the risk that national governments try to free ride.
• Heterogeneity across Euro Zone member states renders centralized monetary policy difficult. Without national monetary policy instruments, prices and wages need to adjust more in the face of asynchronous business cycles.

Previous solutions:

• The stability and growth pact was meant to address the first issue. It failed, for political reasons. Markets didn’t impose sufficient discipline either; they anticipated bailouts.
• Hopes for reduced heterogeneity—as a consequence of EMU—have been shattered.

Reforms so far:

• During the crisis, member states established rescue funds and agreed on various crisis measures.
• They pursued a two-pronged strategy. On the one hand, they tried to build on the decentralized approach of the Maastricht treaty. On the other, they aimed at closer integration in the form of banking, fiscal and eventually, political union.
• Major responsibilities in the area of banking supervision and resolution have been transferred to the European Central Bank. Bail-in procedures have been agreed upon.
• No major changes occurred in the fiscal policy domain. The “Six-pack” and “Two-pack” measures to strengthen fiscal discipline, coordination and supervision have proved ineffective (e.g., no action against France).

Proposals and discussion:

• The recent “Five-presidents’ report” distinguishes between short-term (until 2017) and longer-term (until 2025) measures (see below). The report proposes to strengthen the existing framework before moving towards closer integration (Euro treasury, macroeconomic stabilization, fiscal and political union). France and Italy have voiced support.
• Fiscal union entails a common budget and potentially, a common unemployment insurance. Unity of liability and control would require that fiscal competences are centralized as well. In turn, this would require changes of the European treaties.
• A further strengthening of banking union, e.g. delegation of banking supervision to a newly created European authority (rather than the European Central Bank), also would require treaty changes.
• But throughout Europe, there is no desire to delegate powers to “Brussels.”
• Instead, skeptics like the Bundesbank or the German Council of Economic Experts advocate a bankruptcy procedure for Euro-zone governments: to strengthen discipline and encourage monitoring by financial markets any assistance by the European Stability Mechanism should be preceded by private creditor bail-ins (extensions of maturity, haircuts).
• Some observers also advocate exit from the Euro zone as an ultima ratio measure. But others argue that this very possibility would undermine the stability of the Euro area.

Five-president’s report:

• Commissioned in October 2014 by the heads of state and government, the report has been published in June 2015 by presidents Jean-Claude Juncker (European commission), Donald Tusk (European council), Jeroen Dijsselbloem (Euro group), Mario Draghi (European Central Bank) and Martin Schulz (European parliament).
• In the short term, the report proposes: to improve elements of the previous “six-pack” and “two-pack” reforms, including streamlined coordination and supervision of national fiscal policies;
• a common backstop for national deposit insurance systems;
• a European fiscal council serving as watchdog; and
• independent national agencies to monitor competitiveness.
• For the longer term, the report proposes: completion of monetary union and fiscal union;
• macroeconomic stabilization, stopping short of permanent transfers or income equalization schemes; and
• a Euro zone treasury.
• Accountability as well as the role of national parliaments and the European parliament in coordinating fiscal policy is to be strengthened. The Euro zone is to be better represented vis-a-vis third parties. Intergovernmental arrangements (for example the European Stability Mechanism) that were created during the crisis are to become integral parts of the EU treaties.