Four months on from the UK vote to leave, the European Union is less inclined to dismiss Brexit as an event of little significance and more likely to start facing long overdue reform. Discussion on changes needed in the euro area could begin by December 2019.
Defining a core euro area involving a fiscal and banking union will have to be openly discussed, as Germany and the Netherlands have already done informally with Belgium and Austria. Even if the euro area experiences a significant crisis, these countries will ensure that a small euro area persists.
Who will be their partners? Much will depend on the outcome of elections in France in April and May. But while Germany in the past would have automatically insisted on French membership, there may not be the level of public support required to include France, at least initially, following German elections in late 2017.
German public opinion is also very unlikely to accept any system of automatic money transfers to Italy, even if Germany persuades the European Central Bank to abandon its quantitative easing programme ahead of its 2017 polls, and there is fiscal reflation in Italy and other euro area countries. Spain, Ireland, Luxembourg, Cyprus and Malta would want to be part of the euro area core (though all aside from Spain would need to address questions over tax status first).
Although the core countries cannot throw other countries out of the euro area, they can make them ineligible to be part of the core because of the way that core has fixed the initial criteria for fiscal and banking union. The weakest countries would become more vulnerable to speculative moves aimed at destabilising their economies. But if they can survive such speculation, they could remain in the euro area, even though they were not protected in the same way as core members.
A core euro area would not be divided into north and south in the sense of a formal geographical divide, though this may be the appearance. A divide will happen because of the core’s design and disciplines. Countries that stay in the euro area and make the transition will qualify to be part of the fiscal and banking union in time. In effect, this core will become a federal Europe.
The key to a core emerging will be countries’ use of Article 136 (1) of the Treaty on the Functioning of the EU. This states that, ‘In order to ensure the proper functioning of economic and monetary union… the [European] Council shall…. adopt measures specific to those Members whose currency is the euro.’ Article 136 (2) provides that, ‘only members of the Council representing Member States whose currency is the euro shall take part in the vote.’ All they require is a majority within the euro area.
As Jean-Claude Piris argues in his book, The Future of Europe: Towards a Two-Speed EU?, ‘The scope of application of Article 136 is extremely wide, because many measures may be characterised as “strengthening the coordination and surveillance” of the budgetary discipline of the states whose currency is the euro, or as “setting out economic policy guidelines for them.”’ Measures introduced by the core will legally be EU measures and the new criteria will apply to new applicants to the euro area. There could and should be additional transitional arrangements for helping existing members introduce greater discipline. But inherent in this design is that some existing euro area countries will never be able to accept core disciplines.
The as yet unanswered question is whether the German people will give a green or red light to their politicians in late 2017 to save the euro area by developing a core euro area as a fiscal union – one in which financial resources move, through independent decision-making, from the core area’s richer regions to its poorer ones. The members would need to appoint an economic head of the core euro area to work with the European Central Bank. France, meanwhile, needs to address its reluctance to accept even European Commission disciplines within the present framework. Alain Juppé of the centre-right Republican party would have the least difficulty in accepting financial discipline. But Marine Le Pen, the National Front leader, running for the presidency on a platform calling for France to leave the euro area, may have considerably changed the nature of the euro area debate in France.
Much will depend on whether Nicolas Sarkozy or Juppé reach the second-round run-off in France’s presidential election, widely expected to be against Le Pen. Juppé appears more likely to be able to draw votes from the left. But prediction based on past precedent may be misleading.
The ECB is not a normal central bank. If it were, it would have lent to Greece when it faced a run on its banks. If it thought that Greek banks were insolvent, it would have had to recapitalise them and fund them through a properly constructed European stability mechanism. The fact that it has been inhibited from doing so at every turn reflects the flawed nature of legislation governing European monetary union.