Macron Needs to Dream a Little Harder

(Bloomberg Opinion) -- Angela Merkel and Emmanuel Macron have finally laid out their joint vision for the future of the European monetary union. Unfortunately, their Meseberg Declaration looks like a missed opportunity: It is ambitious where it can afford to be vague and modest where it needs to be concrete.

The Franco-German plan will be the foundation for next week's crucial European Council. Many see this meeting of EU leaders as the last opportunity to overhaul the euro zone before next year's elections to the European Parliament. The stakes are particularly high for the French president, who has pushed for a radical transformation of the monetary union.

The two leaders had one priority: completing the banking union project begun in 2012 amid the sovereign debt crisis. It aims to ensure future financial crises are dealt with at the European level so countries are spared the risk of costly bank bailouts.

The euro zone has established a common supervisor — the Single Supervisory Mechanism, which includes the European Central Bank and national authorities — and the Single Resolution Board, an agency which handles bank failures according to a commonly agreed set of rules and using a joint resolution fund.

What's missing is a backstop for the fund in case it runs out of money, and joint deposit insurance, which reduces the risk that customers move their money overseas in a crisis.

The Meseberg Declaration offers little progress on either front.

Merkel and Macron have committed to using the European Stability Mechanism, the euro-zone rescue fund which has intervened in Greece and Spain, to backstop the resolution fund. The creation of a backstop had already been agreed in principle in 2013, but it is certainly welcome that Macron and Merkel are endorsing the idea again and saying it should happen before its original introduction date of 2024.

The trouble is that the exact governance of the backstop remains fuzzy: In theory, the ESM must be able to intervene promptly since most failing banks are wound up over a weekend. However, the two countries have agreed to maintain a role for national governments, which could possibly delay the process. Finally, the two leaders have capped the contribution of the ESM to the size of the resolution fund — 55 billion euros ($64 billion). That won't be enough to deal with a large-scale financial crisis.

At least France and Germany have kept the deposit insurance project alive by saying that political negotiations could start after the end of the European Council. However, the summit offered an ideal opportunity to at least start on the initial steps — introducing, for example, a reinsurance mechanism so national programs have a safety net to fall back on. For all Macron's federalist hopes, banking union will remain a half-built house.

The two appear to have traded off these concrete deliverables for a new vision: a euro-zone budget which would start in 2021. This is well beyond what most observers had deemed possible ahead of the June summit and a significant victory for Macron.

The economic case for a euro-area budget is clear: Weaker member states face significant constraints when battling an economic shock that leaves rest of the euro zone untouched. Membership of the euro means countries don't have an independent monetary policy and can't devalue their own currency. At the same time, some member states' high debt levels make it very difficult to cut taxes and increase spending without provoking an adverse reaction on the financial markets.

In theory, other countries which don't face a crisis or have more fiscal room for maneuver should step in and help. But under the euro zone's current rules, they have no obligation to.

A euro-area budget would rectify that. Countries would make yearly contributions into the fund, which would then be used to help those in difficulties. Help could be made conditional on past fiscal rectitude to reduce the risk of moral hazard.

Merkel and Macron offered preciously little detail on how such a budget would work. In order to be meaningful, contributions would need to amount to more than 0.5 percent of euro-zone gross domestic product, and entail transfers. From previous interventions by Merkel and Olaf Scholz, Germany's finance minister, we know what they have in mind is much more limited in size and involves loans. The euro-zone budget touted here risks being little more than smoke and mirrors.

Of course, there is a more optimistic take: The declaration may be the first step toward a European fiscal union. But if the progress of banking union is any guide, we shouldn’t be too hopeful. Macron will need to press harder to achieve his dream.

©2018 Bloomberg L.P.