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EMU’s future: less monetary engineering and more financial engineering?

What is the future of Europe’s Economic and Monetary Union (EMU)? And what can we expect from a new European leadership in this policy area after the European Parliament elections in June? It is fair to assume that now the Stability and Growth Pact review is behind us, we can expect quite minimal reform ambitions.

Given the recast of seats in the European Parliament, grand designs and major institutional reforms —which are actually overdue to ensure EMU's long-term functionality—can, however, already be discarded. Arguments based on economic rationality are unlikely to bite. In other words, it is very likely that the existing modus operandi that govern our single currency and fiscal and monetary policies will remain, strictly speaking, unchanged.

However, the completion of the Economic and Monetary Union is currently overlapping with two parallel agendas about completing the European Banking Union and the Capital Markets Union. The latter, in particular, has received a strong tailwind with the recent push made at the level of heads of state and government to aim for more tangible results soon.

Harnessing more capital for Europe’s defence seems to be the red thread that connects Europe’s renewed interest in fiscal conservatism and the CMU project. The rationale is indeed, as stressed amongst others by Lindner and Mack (2024),  that Europe is becoming aware that the level and number of its new ambitions (defence, green transition, digitalisation, and strategic autonomy) cannot be met by public finances alone. Private capital holds a key to meeting these ambitions.

A certain French-German convergence on the need for such blended finance is being noted, largely out of mere material necessity. The French government realised only recently that it is much more indebted than it thought it was, while the Germans have their backs against a debt brake wall.

A decisive question is therefore how public capital can unlock private capital without further burdening national budgets. The European Investment Bank and its experience in relying on public guarantees in the most basic or sophisticated forms will be crucial to raising large quantities of private capital for public purposes in a supranational way.

As a matter of fact, the EIB has started taking action. There are also discussions about Eurobond or defence bonds these very days. However, there is skepticism that this classic form of mutualisation will be a road that all euro area member states will be ready to go down together. And yet, defence bonds might find some appeal among a smaller coalition of euro area member states and could include countries who are traditionally reluctant towards further fiscal mutualisation but which, in the current context, could open up to this possibility in the face of a Russian threat (e.g. Finland and the Baltics).

“Can something like NGEU be engineered for defence purposes?” is the question on many people’s lips. Can it be done? Some early signs, such as the recent announcement of the launch of a European Defence Industrial Program (EDIP) and the joint purchase of military equipment, show that there is certainly a potential for lines to move, even though these new facilities remain small-scale.

Regardless of the ultimate financial engineering solution retained (some forms of supranational bonds, EIB funding, pooling national guarantees), the idea will be the same: how to leverage the size of the European Union in order to scale up the financing of public goods.

This is a new paradigm. One that has been called for years ago by leading EMU experts. The paradigm shifts away from regulatory integration towards the development of state capacities at the EU level, but in a way that still binds in and ensures national ownership.

Why would deeper capital markets make EMU sounder? The usual argument is that it will help EMU develop stronger risk sharing capabilities which will in turn make Europe’s economy more resilient to economic shocks, thereby also reducing the need for active macroeconomic stabilisation. Beyond the EMU macro benefits, one should not overlook the fact that deeper capital markets will be of great help to ease access to finance to many European Small and Medium-Sized Enterprises. It can therefore be expected that positive real economy effects on growth, productivity, and employment could follow suit from a more activist policy agenda on the Capital Markets Union.  

The recent impasse reached in the area of European Banking Union completion, be it on the side of a fiscal backstop or on the side of EDIS, is showing that absent a deep economic crisis, political will proves to be missing to complete an architecture that shows obvious limitations. Rational design is an unlikely method to complete EMU. Security threats, instead, be they driven by a neighbouring war or by serious climate-induced impacts on our well-being, are likely to be far more convincing arguments for politicians to defend a new set of measures to develop a stronger and more financialised EMU.

Pierre Schlosser is the Deputy Director of the Florence School of Banking and Finance, an executive education and policy debate programme for financial stability professionals that forms part of the Robert Schuman Centre at the European University Institute. Pierre holds a PhD in political and social sciences (European University Institute, Florence, 2016), a postgraduate master’s degree in EU economic studies (College of Europe, Bruges, 2008), and a master’s degree in economic governance (Sciences Po Paris, 2007). 

All opinions expressed in the blog section are solely of the authors.