The failure to build adequate fiscal buffers during times of economic growth means that during recessions governments are forced to implement fiscal policies that are more pro-cyclical than would otherwise be the case. Some in this audience may respond that these policy requirements were evident to sharpeyed observers. Indeed, the ECB had been making these points for many years. But they were not so widely acknowledged as to make a difference. For every economic argument in favour of policy adjustment, a contrary one could be found justifying the path taken. This meant many euro area countries did not internalise the policy requirements of monetary union. In fact, almost the opposite policies were pursued in some countries. The lack of an adequate regulatory and macro-prudential framework meant that in many economies the banking sector supported an unbalanced and unsustainable expansion of credit during the period of low interest rates. The financial sector also became overleveraged and engaged in excessive risk taking. Although at the time many in the financial industry justified this with arguments about how financial engineering created possibilities for sophisticated risk diversification, a posteriori it has become evident that risk was seriously mispriced in the period before the crisis. National wage-setting and labour market regulatory frameworks have also proved to be inadequate. Rather than resisting nominal trends, before the crisis strong wages put pressure on price competitiveness, often justified by theories of catching-up effects. Fiscal discipline also proved too lax.
Markets expect quick, bold and “shock-and-awe” decisions on highly complex matters. They are exasperated that something can be agreed by leaders but take months to enter into force. Yet this is a necessary condition of operating in a system of 17 sovereign democracies. Decisions have to be explained, approval processes have to be followed, compromises have sometimes to be made. These dynamics were witnessed even in the US when Congress sent back the TARP in 2008. The net effect on the euro area, however, is that by the time decisions are eventually implemented the expectations of market have moved on. The impact of those decisions is then discounted. These market-democracy dialectics provide a second reason why a more integrated economic and financial union is so essential for EMU. The rationale for the original design of EMU – with centralised monetary policy, but decentralised economic policies – was linked to principles of subsidiarity and democratic accountability. This was consistent with the environment that prevailed 20 years ago. But these same principles now imply more Europe, not less. Subsidiarity is the principle that the centre should perform only those tasks which cannot be performed effectively at the national level. Can we really argue, in the current crisis, that the centre is not the more effective level to exercise, or at least coordinate, certain economic and financial policies? Democratic accountability is the principle that citizens should be able to hold their representatives responsible for decisions.