The European Union (EU), and its Economic and Monetary Union (EMU) are a unique entity – with diverse sovereign countries united in select common policies. Given its setup, crisis management in Europe is always complex. In the last 15 years, Europe has been put to the test with four major crises – the global (subprime) financial crisis, the euro crisis, the Covid-19 pandemic, and the current economic and political fallout of the war between Russia and Ukraine.
Each of these crises was different in nature, and commanded varied policy responses from the EU. What was common, however, is the integration strengthening that has emerged from each crisis, together with the creation of new institutions that are meant to make the EU more resilient.
In a public lecture on 19 May 2022 at the Lee Kuan Yew School of Public Policy (LKYSPP), chaired by Prof Danny Quah, Dean and Li Ka Shing Professor in Economics (LKYSPP), Mr Klaus Regling, Managing Director of the European Stability Mechanism, shared his insights into the four major crises and how the EU worked towards resolving each of them. He also discusses the way forward for European integration.
When the European Union was created in 1952, starting as the European Coal and Steel Community, and later the European Economic Community, it was initially focused on the integration of countries that were former enemies during two World Wars.
Today, the EU is made up of 27 member states – 19 of which share a single Economic and Monetary Union (EMU) and single currency. These 19 states are home to 340 million people with a further 175 million people outside of the EU whose countries’ currencies are linked to the euro.
How America affected the EU
“The global financial crisis was triggered in the US by the housing markets,” recaps Mr Regling on the first major crisis, “[known as] the subprime crisis when US banks gave and securitised loans without doing due diligence, and liquidity had been too generous for too long.”
That trigger reverberated globally due to the interconnectedness of the financial system. Trust in banks was at a low, leading to a chain reaction of credit crunch, worsening economy and a drop in the world Gross Domestic Product (GDP) for the first time since World War II. The euro area was particularly hit, explains Mr Regling, noting that it is a mature economy with low trend growth.
The crisis was partly due to the weakness of bank supervision; there was an attitude that the markets would regulate themselves. Today we talk about “macro-prudential policies” – “a term that did not exist in the 1990s,” notes Mr Regling, which means that supervisors need to look at the macro picture of bank lending. Also rating agencies failed; they gave away AAA ratings to financial instruments too easily.
In response to the crisis, governments had to use fiscal policy to stimulate demand, and some private sector institutions had to be bailed out. These were the heydays of good, global policy coordination. The G20 heads of state took a lead to design a response to this global financial crisis. This strengthened financial oversight, as well as bank and rating agency regulations. Some of these were lasting improvements that later helped us deal with other crises.”
A crisis in the cradle of Europe
Soon after emerging from the global financial crisis, Europe faced its own problems. During the first 10 years of the monetary union, lax policies eventually resulted in loss of competitiveness, high levels of public debt and unemployment in some countries. “It started in Greece, but very quickly spilled over to Portugal, Ireland and later on, to Spain and Cyprus; these countries lost access to financial markets or faced very high interest rates for their borrowing. The crisis then affected the entire euro area GDP between 2009 to 2013” explains Mr Regling.
Weak coordination of policies at the EU level and the lack of a lender of last resort for euro area sovereigns contributed to the crisis. The EU, then, had to design a response adapted to these novel causes. To address the gap in the institutional architecture of monetary union, the temporary European Financial Stability Facility (EFSF), and soon after, the permanent European Stability Mechanism (ESM) were created. Both institutions disbursed €295 billion to the abovementioned five member states. This gave them the time to implement reforms, needed to address the weaknesses of their economies. The countries carried out an “internal devaluation”, i.e. cuts in nominal income to restore competitiveness. In addition, the creation of banking union, with institutions for European-level bank supervision and resolution, made banks safer and strengthened financial stability.
The curse of Covid-19
A decade after the euro crisis, the “symmetric shock” of Covid-19, as Mr Regling terms it, affected Europe and the world deeply and in unprecedented ways, with over 6 million human lives lost. “The lockdowns meant significant decline in growth,” he says, “with a minus 6.4 per cent GDP drop in the euro area.”
On policy response, Mr Regling says, “fiscal measures were necessary, and governments around the world adopted support measures for households, businesses, and workers. Europe had additional programmes at the European level which came on top of the national measures. These were put in place alongside expansionary monetary policies.”
Compared to the US, Europe’s policies supported businesses to a greater degree than individual households to stimulate longer-term growth. As part of this supply-side approach, the EU introduced a programme designed to support public investment and additional reforms in member states.
When war returned
Barely catching a breath after the Covid-19 pressures died down, the outbreak of war between Ukraine and Russia at Europe’s doorstep brought on another economic challenge.
Says Mr Regling, “the [recovery] momentum was strong after the pandemic, until 24 February this year, when the war in Ukraine started.” The economic fallout was felt especially in Europe, due to the region’s geographical proximity to Russia. A rapid rise in inflation due to hikes in energy and food prices were felt quickly and sharply; and with it, increased financial market uncertainty, as well as both consumers’ and investors’ unease. With the Covid-19 pandemic still present in certain countries, the overlap in these crises inevitably affected global trade and GDP growth. Due to energy import dependency, “Europe is experiencing its biggest terms-of-trade loss in half a century, larger than even the oil crisis of the 1970s,” cautions Mr Regling.
The European policy response to accelerating inflation is to tighten monetary policy; accelerate the transition to clean energy sources; and, also unsurprisingly, directing more to defence spending.
Preparing for the future
Further measures are needed to make Economic and Monetary Union more resilient to future crises, said Mr Regling. This includes the creation of a capital markets union, the completion of banking union, and establishing a central fiscal capacity.
Furthermore, the leaders of two key EU member states – France and Italy – have put forward new proposals for deepening European integration, which would allow for closer cooperation in selected areas. These are steps that would unify the EU into a more singular political identity, but are not easy to carry out, as a new EU Treaty would have to be agreed and ratified by all member states.
“Looking back at the crises that Europe successfully coped with, the silver lining is that crises can push forward difficult policy topics, and that can lead to more integration and resilience,” concluded Mr Regling.
Listen to the full public lecture on Europe’s Growing Resilience to Crises here:
View Mr Klaus Regling’s presentation notes HERE