Don’t Let Italy Block Euro-Zone Reform

(The Bloomberg View) -- The fight between Italy and the rest of the European Union over Rome’s rule-defying budget has only just begun, but it’s already causing serious damage. Above all, the dispute is delaying Europe’s plans to strengthen the monetary union. That’s an effort that cannot wait — because a crisis in Italy might test the resilience of the euro zone like never before.

In an unprecedented rebuke, the European Commission rejected Italy’s budget. But the squabble has renewed the fears of many politicians, especially in Germany, that their taxpayers will end up paying for the fiscal recklessness of others. Mutual trust is the precondition for a stronger monetary union. Already in scarce supply, it’s disappearing quickly.

In the first half of this year, France and Germany negotiated plans to revamp the monetary union, and in June the union’s leaders began to put them into action. The European Council agreed, for example, to give the EU’s single resolution fund additional resources for dealing with a failing bank.

These proposals are valuable but fall short of what’s required. The euro zone needs a common deposit insurance scheme, to limit the risk that a banking crisis might push a government toward default. Europe also needs elements of a fiscal union, to help countries that are experiencing an isolated economic shock. Mario Draghi, president of the European Central Bank, has supported the first idea and seems sympathetic to the second. But some euro-zone members fear such plans would lead to permanent fiscal transfers from north to south.

EU leaders meet again in December, but the prospects for an ambitious deal look poor. French President Emmanuel Macron has led the effort up to now, but his support at home is crumbling. Angela Merkel, Germany’s chancellor, has lent Macron support, but recently announced she won’t seek a new term in 2021, calling her ability to drive policy into question. Most important, Italy’s contempt for the fiscal rules will make other member states leery of setting up new safety nets.

Those fears aren’t groundless, but there are ways to deal with them. Sensible euro-zone reforms would include measures to ensure that countries don’t abuse any new protections. The EU should be confident, for instance, that a country’s debt is sustainable before lending new money — and, if it isn’t, governments should insist on restructuring. The riskier the bank, the more it should expect to pay for deposit insurance. With these and other safeguards, closer fiscal cooperation needn’t be a license to binge. 

Time is short. Italy’s government has spooked investors, pushing up bond yields. Italy’s economy is slowing, which could trigger fresh fears over the sustainability of its public debt. Except for Greece, the rest of the euro zone has suffered very limited contagion as yet, but that might not last. If Italy’s bond yields keep rising, investors could start betting against the debts of Portugal or Spain.

Italy’s bad behavior is no reason to postpone a deepening of the monetary union — just the opposite. It shows that well-designed cooperation, with stronger incentives for good fiscal conduct, is essential for the success of the project.

Editorials are written by the Bloomberg View editorial board.

©2018 Bloomberg L.P.