Readjustment of Macro Imbalances in the Eurozone Piotr Malec, malecp@uek.krakow.

pl Summary: The debt crisis has revealed deep differences between the economies participating in the monetary union in many areas of economic life. Already Delors report in 1989 warned against the dangers of various fiscal policies within the monetary union countries. The experience of the functioning of Economic and Monetary Union also revealed shortcoming in the common monetary policy. The main goal of this article is to diagnose the level of macroeconomic imbalances in the eurozone, their main causes and above all the indication of the possible solutions to this problem. The main background of the publication will distinguish two groups of countries that share the euro: the economies of the core and peripheral economies. The author subsumed Germany, France, Netherlands, Finland and Austria under the category of the economies of the core. Peripheral economies in the study are represented by Greece, Ireland, Italy, Spain and Portugal.

Keywords: macro imbalances, monetary union, core-periphery eurozone, Titel of the Working Paper (in Czech) Subtitle (in Czech) Name of the author without academical degrees (e-mail) Abstrakt: Abstrakt in Czech abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstract abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt. (justified; precisely 10 lines) Klov slova: klov slovo, klov slovo, klov slovo. JEL: A00, B01, C01 abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt abstrakt

Content Introduction .................................................................................................................. 7 1. The Euro zone in the first decade: hopes and fears .......................................... 8 2. Causes of macroeconomic imbalances.. ............................................................ 11 2.1 Monetary policy .............................................................................................. 12 2.2 Fiscal policy ..................................................................................................... 14 2.3 Structural reforms ............................................................................................17 3. Readjustment of macro imbalances in the Euro zone..................................... 17 Conclusion................................................................................................................... 22 References ................................................................................................................... 23

... an Economic and Monetary Union could only operate on the basis of mutually consistent and sound behaviour by governments and other economic agents in all member countries. () Uncoordinated and divergent national budgetary policies would undermine monetary stability and generate imbalances in the real and financial sectors of the community. Delors report (1989)

Introduction The creation of EMU was an event without precedent in modern European economic history. The euro has become one of the most important elements of the process of economic integration in Western Union initiated more than half century ago (European Commission 2008:17). In 1999, eleven Member States turned their national currencies to a common currency the euro. Currently, the monetary union brings together seventeen states. Economies that joined the eurozone most recently such as Slovakia and Estonia, have made it in the period of the global financial crisis which affected the economic condition of the entire group particularly adversely. Until the outbreak of the global crisis the euro could called a success on a global scale. But the crisis initiated in Greece has triggered debt crisis in the Eurozone, especially in peripheral economies. Crisis phenomena revealed numerous shortcomings in the architecture of the European monetary union and led to significant economic divergence between countries which use common currency. Meanwhile, when the project was implemented the expectation were entirely different. The transition to a higher level of economic integration was to be important impetus to the development of convergence of economic structures, and was supposed to reap many benefits leading to an increase in the prosperity. The main purpose of the article is to diagnose existing imbalances among the member states that use the common currency, which were drastically exposed due to the debt crisis. The article consists of three main parts. The first part will present main macroeconomic achievements which the Eurozone countries have managed to make through the prism of declared targets set by the European Union decision-makers. This section shall focus on the spectrum of current macroeconomic imbalances observed among the member states. The second part of the paper shall be devoted to a demonstration of the major causes of increasing macroeconomic imbalances in the Eurozone. The last part of the article shall describe the main activities that in the authors opinion should necessarily be initiated in the Eurozone in order to readjust such profound differences between the member states.

1. The Eurozone in the first decade: hopes and fears The euro area is not only a purely technical economic project but also a politician project, in which at least two generations of politicians on the Old Continent were involved (Morawski 2010). Fierce determination of the German Chancellor H. Kohl, who strongly objected to the introduction of common currency despite the fact that as many as 80 percent of the German society were opposed to that may be considered a confirmation of this fact. This dramatic step was mainly a consequence of the dream to make Europe one of the major players in the international arena, the construction of European identity and the vision of to realise the European unity (Ponnuru 2011). In order to make that dream come true, an agreements was made to admit completely unprepared economies to that elite club of economies. The best example is Greece, which at the time of the creation of the euro area did not meet all the convergence criteria. The creation of an optimum currency area was not accompanied by the adoption of optimal solutions based on objective economic data. Within the economic dimension the introduction of the euro was intended to achieve three main objectives (EC 2008: 17-18): ensure greater macroeconomic stability, accelerate economic growth and create new jobs, compensate for macroeconomic imbalances existing between the countries forming the monetary union. The first two objectives have been achieved. The main objective of the European Central Bank which was set up in 1999 is to ensure price stability in the countries that share the euro. Price stability the optimal level of inflation rate is defined in the euro area as below but close to 2 percent in the medium term. The first decade of the euro shows that this objective has been achieved. Over the past twelve years the average inflation rate in the euro area has stood at 1.97 percent. It is worth emphasizing the fact that this objective was achieved, despite numerous financial perturbations occurring in recent decades such as the Internet bubble burst, the terrorist attacks of 2001, soaring oil prices, rising food prices or a collapse in the mortgage market in the U.S. (Trichet 2011). The adoption of a common currency had a positive effect on the functioning of the single market companies in the euro area. The single currency has forced European companies to improve efficiency, due to stronger competition on a continental scale. Transaction costs have fallen, companies have been given the option of cheaper financing, risk premium has also been reduced. The companies are not threatened with the devaluation of their economic partners, the prices have become more transparent. Employment growth was not spectacular, averaging 1.3 percent but it was higher than that in the United States (1.2 percent). Since the establishment of the monetary union to the beginning of the global financial crisis 14 million new jobs were created in the eurozone, which is 6 million more than is the corresponding period in the United States. Real GDP grew in the period from early 1999 to mid-2007, an average of 2.3 percent. GDP per capita in the eurozone grew at approximately the 8

same rate as the United States (Economist Intelligence Unit 2011:36-37). The abolition of all trade barriers and exchange rate risk increased turnover within the eurozone by 50 percent within the first few years of the functioning the single currency, and the turnover of the European Union with the rest of the world increased by as much as 80 percent. Decreasing transaction costs sparked a creation effect on trade between the eurozone economies. The value of exports and imports within the European monetary union has increased from 1/4 of the GDP in 1998 to 1/3 in 2007, currently 50 percent of the trade across the euro area is conducted between countries which use common currency (Trichet 2011). The biggest problem, however, which the economies of the euro area, are currently facing is the fact that the third goal i.e. bridging the macroeconomic imbalances has not been achieved. The intention of the creators of the euro area was to ensure that the entrance to the currency union of lessdevelopment countries (such as Greece, Spain, Portugal) would give them a positive boost so that they could match the leaders (such as Germany, France, Netherlands). The crisis has revealed, however, huge differences between the economies of the euro area. Worse yet, these differences enlarge, rather than diminish and they may prove unbridgeable without much control by the parent bodies of the European Union (Wesoowska 2011). The global financial crisis has made the euro area split into two groups: the core, where economic fundamentals remain good and the periphery of the euro area, which fell into the vicious circle of the economic recession combined with the loss of liquidity (Ireland, Portugal) and insolvency (Greece). Member States differ in the implemented fiscal policy, labour efficiency, the amount of income or the level of national savings and debt. A detailed comparison of the core and the periphery of the euro area is presented in table 1. The differences between the core and the periphery of the euro area also have a cultural background (Greenspan 2011). As a result of historical and cultural conditions prevailing in the countries of Southern Europe two contemporary institutional plagues bothering the economy such as corruption and shadow economy became deeply rooted in those countries. Both of these institutional weaknesses are a proof of very poor quality of state institution in this region, a small degree of citizens trust in state institutions and they negate social solidarity to a large extent. All this contributed to the development of large scale phenomena such as clientelism, nepotism or patronage. The summary of the 1st decade of the euro area through the prism of its residents opinions shows that it is relatively weak against the background of the European Union membership. Recent research results show that EU membership is seen as more favorable to the individual Member States rather than adoption of common currency. 67 percent of the respondents admitted that their countrys membership in the EU had a positive impact on their economies.

Table 1. Current macro imbalances GDP per capita (PPS)2 Real GDP growth (%)3 Shadow economy (% of GDP)1 Gross national savings (% of GDP)1 Current account balances (% of GDP)2 Employment growth (%)3 Unemployment rate (%)5 Youth unemployment rate (%)2 Budget deficit (% of GDP)2 Primary deficit (% of GDP)2 Gross public debt (% of GDP)2 Private debt (% of GDP)1 Harmonised long-term interest rates (%)6 CDS cost (b.p.)4 Cumulative probability of default (%)4
1 in 2

Core eurozone 37,1 +3,9 11,8 21,8 +2,8 +1,0 6,4 14,5 -4,6 -2,4 69,7 199,6 3,2 51,1 4,5

Periphery eurozone 30,1 -0,8 19,8 11,3 -6,2 -2,4 14,0 31,6 -13,2 -9,5 102,2 264,6 10,4 824,0 42,1

2009 in 2010 3 in the first quarter of 2011 4 in the second quarter of 2011 5 April 2011 6 July 2011

Source: A.T. Kearney, Credit Market Analysis, European Central Bank, European Commission, Eurostat, International Monetary Fund.

In the case of countries that share the euro, the satisfaction with the adoption of the euro is much lower and amounts to only 40 percent. Up to 53 percent of the respondents felt that joining the monetary union had bad consequences for the national economy. The outcome of the survey is presented in chart 1 below.
100 75 50 25 0

EU Membership's Effect on National The Euro's Effect on National Economy Economy Good Bad

Chart 1. Positive effect on Economy: EU Membership's vs. Using the Euro (EU 12)
Source: Transantlatic Trends 2011.

10

The biggest supporters of EU membership are Germany (74 percent), Poland (74 percent) and the Netherlands (73 percent). Skeptical approach to the membership was revealed by the British and the Bulgarians (46 percent). Among the speakers of the vast majority of euro countries (53 percent) believe that adoption of the euro had an adverse influence of on the health of their economies. The Italians (49 percent) are most satisfied with adoption of the euro. The Spanish (54 percent) and the Portuguese (58 percent) are the most dissatisfied members. The results for selected core economies of the euro area and the peripheral economies are presented in chart 2.
100 75 50 25 0

Good Source: Transantlatic Trends 2011.

Bad

Chart 2. The Euro Effect on the National Economy

2. Causes of macroeconomic imbalances The conclusion to be drawn from the theory of OCA R. Mundells are that the countries joining the monetary union can get rid of the foreign exchange risk which should significantly contribute to lowering transactions costs. On the other hand, these economies are getting rid of the two instruments from the absorbing area of monetary policy, i.e. the possibility of establishing a sovereign interest rate and exchange rate policy (EIU 2011:36). Economies that do not have a flexible labour market or a healthy system of public finances may incur the high costs of participation in the monetary union if they are affected by an asymmetric shock. The debt crisis has confirmed that the euro area is not an optimal currency area, what is more, membership in the monetary union has not triggered the desired adjustment mechanisms in support of the OCA in the countries that adopted the single currency. Alternative adjustments mechanisms such as labour mobility, wage and price flexibility, limited progress in financial integration and the lack of cross-border fiscal transfers have proved to be insufficiently effective in a crisis situation (Kalinowska 2011: 219-221). There are many reasons that contribute to the emergence of imbalances within the countries that share the euro. In the authors opinion the key role was played by 11

the macroeconomic policy, as well as the heterogeneous nature of the economic policies of individual Member States. 2.1 Monetary policy The key understanding the current turmoil in the eurozone is to understand the specific architecture of the Economic and Monetary Union (Trichet 2011). The introduction of the euro initiated the implementation of single monetary policy in the single currency. From now on, Member States have lost control over the possibility of determining the sovereign interest rate and ability to devalue their currency. Many economist warned that the common monetary policy would not suit all the ECB sets the same interest rate for both the core eurozone economies, more developed and technologically advanced and capital intensive as well as peripheral economies (except Ireland) with lower level of development, mainly agricultural manufacturing (Zeihan 2010). Countries such as Germany, Finland and the Netherlands are the countries whose economies are based largely on exports of highly processed goods and modern services. Others, like Greece, Portugal and Spain are the economies which are driven by domestic consumption and tourism. In the case of peripheral economies the problem is not only a loss of price competitiveness, but the fact that the offer did not represent high quality and branded products. These countries have specialized in the segment of low and medium tech products, and often lose out in global markets with China, Vietnam and Taiwan (Mauro, Foster 2010:119). These observations are confirmed by empirical data. There is a big technological gap between the core economies of the euro area and the periphery. Performance in the euro area in relation to the performance of the United States as presented in the chart 3 only confirms it. Labour productivity in the core is nearly 90 percent as compared to the performance of the U.S. economy. In the case of countries of southern Europe and Ireland, this ratio is much lower and amounts to only 67 percent.
100 80 60 40 20

United States

core eurozone

periphery eurozone

Chart 3. Labour productivity (United States = 100)

Source: The Conference Board.

12

Peripheral economies, despite their membership in the monetary union have failed to increase labour productivity. Back in 1995 the Spanish labour productivity was 95 percent of the productivity of the German economy. In early 2007, this ratio fell to 80 percent level. Portugal recorded even a deeper decline in productivity. While yet in 1997 it corresponded to 82 percent efficiency as compared to the performance of Germany, already at the beginning of 2007 it represented only 73 percent (Wishart 2011). Another important aspect in implementing the single monetary policy in the eurozone is the level of real interest rate. Common fixed interest rate for all eurozone countries causes low-inflation economies to be confronted with relatively high real interest rate, while the economies with high-inflation are confronted with low real rates (aski, Podkaminer 2010:271-272). In the years 2000 2010 the average inflation rate for the economies of the core was 1.9 percent, while for the peripheral it was 2.7 percent (see: chart 4).
3

core eurozone

periphery eurozone

Chart 4. Inflation rate (%)

Source: Eurostat.

The consequences of this are as follows: really high interest rate inhibit economic growth, contribute to the stagnation of wages and a very slow growth of unit labour costs, and low real interest rates provoke a credit boom, rapid wage growth and a rapid increase in unit labour costs (aski, Podkaminer 2010). As a result of these different adjustment process a group of countries with low inflation, is increasing its competitiveness relative to countries with high inflation. An imbalances between these two groups of countries is growing. Diversified growth of unit labour costs in the individual euro area countries is one of the main causes of the current crisis. The appreciation of the euro against the dollar has a different impact on different eurozone economies. The impact on competitive economies such as Germany one is weaker as the growth in unit labour costs is negative in that area. Unlike the situation in peripheral economies, where robust growth in unit labour costs at a high rate of the euro meant that exports of these countries have become uncompetitive. The consequence of this was an increase in unemployment and fiscal problems. Common monetary policy led to inflation and wage pressures. In Ireland, unit 13

labour costs in the years 1999 2007 grew fastest in services and construction, but decrease in the manufacturing sector. In Spain and Portugal, the increase in unit labour costs was most pronounced in non-tradable sectors. In Greece, the increase took place both in the tradable goods sector and the non-tradable goods sector (EIU 2011:37). Bond issued for this purpose by countries of southern Europe were regarded as equally safe as those issued by Germany. A considerable amount of money flowed into Greece, as Spain and Ireland recorded a stock market boom in mortgage financing. The influx of capital to the peripheral economies due to import the entire financial credibility of the euro area caused a consumption and investment boom in these countries. In Spain and Ireland the booming property market contributed to a large increase in demand for construction workers which in turn led to high wage growth in this sector. These wage-related gradually spread to impulses the remaining industries in these economies. The rapid growth in property prices encourage further investment financed by low interest rate credits. Income growth translated into rapidly growing imports, and finally a large current account deficit (Sinn, Buchen, Wollmershuser 2011:50). In the case of Portugal and Greece loose fiscal policy and the inflow of funds from the European Union contributed to the large increase in domestic demand. The idea of a common monetary policy was incomplete from the outset. The same level of interest rate was determined for economies considered technology leaders which gained new markets thanks that and the economies whose share in world trade has declined. In addition, low real interest rates on the periphery of the eurozone, resulting from higher inflation in these economies has contributed to an uncontrolled housing (Spain, Ireland) and consumer (Portugal, Greece) boom. 2.2 Fiscal policy A unique of the European monetary union is that the common monetary policy implemented by the ECB is accompanied by a decentralized fiscal policy at the level of individual Member States. The experience of the first twelve years of EMU suggest soft coordination of fiscal policy for countries that share the euro hasnt worked. Consequently, we are now dealing with the acute crisis of public finances of Member States (Trichet 2011). The crisis showed that irresponsible macroeconomic policies, deficits and public debts, which are beyond control and macroeconomic balances increased the susceptibility of some countries to the crisis. Countries with a balanced budget policy, and advanced structural reforms survived the crisis in a better shape. In the years 2000 2010 fiscal rules set forth in the Treaty of Maastricht (the public sector deficit below 3 percent GDP) were violated seventeen times in the core eurozone countries and as many as thirty two times in the periphery. This is confirmed by chart 5.

14

40

30

20

10

core eurozone

periphery eurozone

Chart 5. Broken fiscal rules

Source: Eurostat.

In the period 2000 2010 Greece exceeded the allowable limit of the budget deficit as many as eleven times. The situation in the remaining countries of the eurozone wasnt any better in this aspect. Italy exceed the budget deficit threshold seven times. In that eight times Portugal exceed the threshold. Finland economies analyzed in the group had never crossed the threshold of 3 percent GDP. In the last decade of the monetary union, the core economies conducted a more restrictive fiscal policy than the peripheral economies, although even in major economies such as Germany and France there have been cases of exceeding the reference values. Indicators for the budget deficit and public debt for the economies of both groups are shown in the following charts 6 and 7.
5 0 -5 -10

core eurozone
-15

periphery eurozone
2004 2005 2006 2007 2008 2009 2010

2000

2001

2002

2003

Chart 6. Budget balance (% of GDP)

Source: Eurostat

According to forecast by the International Monetary Fund in 2011, all the peripheral economy will break the fiscal rules relating to the budget deficit and public debt. In four of them the public debt will be higher than 100 percent of GDP (with the exception of Spain). At the core of the euro area the fiscal situation will develop much more favorably. Only France will have a high deficit (5,9 percent). Germans and Finns will manage to reduce the deficit below the level of 3 percent GDP. Finland will also be the only country in the analyzed 15

group, in which the debt to GDP ratio will not exceed a threshold of 60 percent. Projected fiscal positions for 2011 are presented in the chart 8 below.
120

90

60

core eurozone
30

periphery eurozone
2004 2005 2006 2007 2008 2009 2010

2000

2001

2002

2003

Chart 7. Public debt (% of GDP)

Source: Eurostat
200

EL

160

periphery
IE IT PT FR ES NL
-6 -3 120

AT

DE

80

core
FI
40 0

-12

Public deficit -9

Chart 8. Fiscal position in the eurozone countries in 2011

Source: International Monetary Fund.

The rules laid down in the Stability and Growth Pact were to protect the entire monetary union against the dangers of loose fiscal policy pursued by the sovereign Member States. In light of the experience of the last decade it became clear that the provisions of the Pact proved to be neither sharp enough nor sufficiently enforceable. Mainly for the politician reasons (the decision were taken by the Council and not by the independent Commission) its enforcement in the largest euro area and peripheral economies proved to be ineffective, undermining his credibility.

16

Public debt

2.3 Structural reforms Divergent economic policies, especially varied progress in structural reforms, also contributed to large-scale macroeconomic imbalances between the economies that use common currency. Most of the core eurozone economies (Austria, Germany, Netherlands) have implemented structural reforms, especially reforms of the labour market and product market in the last decade. This is confirmed by the high position of these countries in the ranking of balanced growth developed by the Lisbon Council. The ranking of balanced growth consists of fifteen economic indicators grouped into four categories: fiscal sustainability, competitiveness and domestic demand, employment and production effienciency and public and private debt. A ranking constructed such away presents a statistical image of balanced growth on the basis of which we can conclude which economy needs to take drastic structural reforms. The worse level the indicator reaches in a given country, the more it threatens the stability of the euro area. Table 2 cleary shows that the peripherial euro area economies are facing the need to change their development model. Table 2. Balanced growth in the eurozone
1 DE 7,4 Core eurozone 2 4 8 AT NL FI 7,3 7,0 5,5 9 FR 5,5 10 IT 4,9 Periphery eurozone 13 14 15 PT ES IE 4,1 4,0 3,5 16 EL 2,9

Source: Lisbon Council

Out of sixteen euro area countries (the ranking does not include Estonia) reffered to in the study, the four last positions in the chart are occupied by peripherial economies. From the perspectives of the current debt crisis the most important conclusion for this group of countries is that mere use of a common currency does not guarantee that high competitiveness in world markets will be maintained is does not exempt them from need to implement difficult structural reforms. 3. Readjustment of macro imbalances in the Eurozone In a wider perspective, the debt crisis of the euro area and the case of Greece, in particular, revealed systemic weakness in economic governance in the European Union. The debt crisis in the euro area reminded everyone that the architecture of the euro area still needs to be improved (see: Table 3). In the opinion of many experts, the structural cause of the crisis in the euro area is that the monetary union in not rooted in a politician union (de Grauwe 2010:1). The same conclusion was reached by Habermas, according to whom the debt crisis in the euro area results from the incomplete politician union (Habermas 2010). When the euro was introduced, many economists argued that the monetary union will ultimately require a politician union (Rachman 2010). In the opinion 17

of Mnchau the experiment with the monetary union without a politician union failed, so the eurozone is currently facing a historical choice between deeper integration and disintegration (Mnchau 2010). In the opinion of Wolf, the eurozone has only two choices: go ahead and create a tighter monetary union or go back and gradually eliminate the euro (Wolf 2011). Overcoming such significant imbalances between the euro area countries requires the development of a new model of integration based on more solidarity between Member States. The euro area in the face of the crisis has to place a bet on the political unity and deeper integration. The results of surveys conducted online by the British weekly, The Economist, also confirm these theses. Since the initiation of the study, i.e. 05.09.2011 to 05.10.2011, 5258 respondents cast their votes online. A vast majority of the respondents (73 percent) concluded that the eurozone needs a fiscal and politician union (see: chart 9). However, the observation of actions taken by the EU decision-makers during the debt crisis leads to the conclusion that there are not enough politician and institutional conditions to make such a bold decision (The Economist 2011). The euro area needs common institutional arrangements for a politician union. Table 3. The new architecture in the Eurozone New solidarity integration New organisation
Fiscal policy Fiscal and politician union European Stabilisation Mechanism Monetary policy Structural reforms

European Supervisory Architecture: European Supervisory Authorities (ESAs) European Systemic Risk Board (ESRB) Euro+ Pact

New institutions

New initiatives New rule New procedure

European Semester Reverse majority rule

Europe 2020

Excessive imbalance procedure (EIP)

Source: European Commission (2010), Europe 2020. A European Strategy for Smart, Sustainable and Inclusive Growth, Brussels, Strengthening Economic Governance in the EU, Report of the Task Force to the European Council, Brussels 2010, European Commission (2010), Towards More Responsibility and Competitiveness in the European Financial Sector, Brussels, European Commission (2011), EU Economic Governance: a Major Step Forward , Brussels.

18

Yes

No

20

40

60

80

Chart 9. Fiscal and politician union in the eurozone ?

Source: The Economist

Today, from perspective of the debt crisis in the euro area it can be clearly seen that the Lisbon Treaty in its current version is inadequate to meet the political, legal and institutional mechanism of action in a crisis situation. The main flaw stems from the fact that the Lisbon Treaty does not provide for a controlled bankruptcy of a eurozone Member States. One of the biggest fears that accompanied the introduction of the euro resulted from the lack of stabilising funds. As long as none of the eurozone countries were threatened with solvency, there was no real need for the operation of such a mechanism. The Greek debt crisis showed that the system monetary union is not prepared for the bankruptcy of a Member States. The European Union has still not developed procedures and mechanisms for the eurozone countries to be rescued from bankruptcy. To allow the European Union for coordinated, rapid and effective response to the financial problems of a Member States in the future, EU policy makers decided to create a new intergovernmental organisation of the European Stability Mechanism (ESM). ESM will be operational from mid-2013, its main objectives will be to take care of the financial stability of the euro area (EC 2010). ESM will have to support the euro area economy in the event of extraordinary circumstances of crisis. In the future, this solutions should reduce both time and the costs saving of the eurozone countries. The idea is to avoid the case of Greece, whose financial problems have contributed to the decline in confidence of financial markets in other peripheral economies. A necessary condition to restore the balance between the eurozone is a credible public sector reform and restoring competitiveness of the peripheral economies. With this in mind, the European Commission proposed a series of actions and initiatives in this area (EC 2010). Ultimately, 28.09.2011 the European Parliament passed a package of six pieces of legislation to reform economic governance in the European Union. A new set of fiscal regulations in the dimension is the reinforcement of the existing Stability and Growth Pact. New solutions will give the European Commission greater opportunities enforce recommendations on fiscal policy from governments and rapidly eradicate economic imbalances. The recent economic crisis has highlighted how important it is to coordinate not 19

only the actions of central banks, but also fiscal policies of individual euro area countries. The Commission proposed a new initiative called the European Semester. The main objective of the introduction of the European Semester is the intention to improve the ex ante coordination of fiscal policies among EU countries. The European Semester is one of the instruments intended to coordinate fiscal policies of EU countries and to help prevent such crisis as the Greek one. Under the initiative in the first half of the year Member States will be required to submit their draft budget for a review by the European Commission and Council. After evaluation by the European institutions a recommendations will be issued for these countries. In autumn the Member States will presents the draft budget to the national parliaments (EC 2011). New regulations proposed by the European Commission provide stricter, faster and more effective sanctions for countries that violate the fiscal discipline. Initially, the regulation which was priority, was automatic imposing financial sanctions on countries violating fiscal discipline, which would mean that they would not be subject to politician negotiations. According, to the proposal from the President of the European Council, Member States should introduce a new principle called the reverse majority rule. Instead, of the majority needed to implement financial sanctions, the majority would be required for its rejection. If the finance ministers of the European Union did not reject European Commissions proposal by the majority of votes, it would automatically enter into force (European Council 2010). In the course of the work in the European Parliament a compromise was reached. The European Commission will be able to give warning to a Member States, which will take effect within 10 days of the announcement, unless the Member States, block it by the majority of the votes. To avoid penalty the state which violates provisions would have to win the support of most governments. In the past years, Member States have taken divergent economic decision, which led to a significant discrepancy in the euro area of competitiveness and macroeconomic imbalances. A new surveillance mechanism has been designed by the European Commission to identify and resolve these issues much earlier. The Commissions proposed regulations introduce a new procedure for excessive imbalance, modelled on the procedure of excessive deficit. The European Commission will examine each year, if there are signs of a dangerous direction the economy has taken (e.g. current account balance, net foreign assets, unit labour costs, house price growth, the increase in mortgage loans, private debt levels) in member countries. When analyzing the causes of macroeconomic imbalances, the European Commission will be making the assessment not only of Member States showing a significant deficit on their current account, but also those that show a significant surplus. This ensures that European Commission will have to take into account the possibility that the source of the imbalance may also be in surplus countries such as Germany or the Netherlands, and they also could be called upon to make the appropriate corrections (EC 2011). In the case of monitoring the macroeconomic imbalances, in practice it may be difficult to determine the threshold beyond which you must begin the process of 20

correcting them. The best example was the proposal of the United States through the G20 forum that economies the which reach a surplus on current account at 4 percent GDP, begin making appropriate adjustments. This was met with firm opposition from economies such as Germany, Japan, China and South Africa. Belke proposes that the causes of existing imbalances ought to be prevented rather than the imbalances themselves. He adds than consumer booms driven by cheap credit are among these causes. In his opinion, one should wait until an equilibrium is automatically reached thanks to market force (Belke 2010:8). For example, a country which recorded a surplus/deficit, should stimulate/decrease domestic demand, which in turn will lead to an increase/decrease in wages. An increase/decrease in wages will worsen/improve the competitiveness of the economy, the ultimate consequences of which, will be the elimination of surplus/deficit on current account. Another important issue related to the creation of excessive imbalances in Belke opinion is that they are considered through the prism of perfect symmetry. Surplus on the current account in some euro area countries is automatically a deficit in others and the restore the balance of these, the former have to reduce their competitiveness, and the latter have to improve it. Such adjustment may, however, in his opinion, result in a deterioration of the competitiveness of the euro area (Belke 2011:9). It is important to focus not only on price competitiveness but also on productivity (Mauro, Foster 2010:117). For this purpose carrying out thorough structural reforms in the countries of Southern Europe seems essential. A good guideline for the reforms may be the recently announced initiative of Europe 2020, which indicates to the Member States the priority lines of action (EC 2010). The next step in this direction is the adoption by the European Council summit of the Euro+ Pact, whose main objective is to promote competitiveness in the monetary union, to promote employment, increase the stability of public finance sector and strengthen the financial sector stability. Countries that acceded to the Pact have committed themselves to: abolish wage indexation, mutually recognize diplomas certifying educational and professional qualifications, progressively unity rules relating to corporate tax, adjust pension systems to demographic trends, introduce provisions concerning the maximum permitted amount of public debt in the constitution, establish a crisis management mechanism for the banking system (EC 2011). The main dilemma for countries that the share the euro rests in the fact that competitiveness is in this case a zero-sum game. For some it is a profit while it represents a loss for others. Restoring competitiveness of the economies of the Mediterranean will require the approval of the fact that the competitiveness of other euro area countries has deteriorated (Gros 2010:1).

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4. Conclusion The analysis conducted in this article confirms the fact that dramatic macroeconomic imbalances exist in the Eurozone countries. Such imbalances have existed from the very beginning of the monetary union formation, however, the debt crisis in the Eurozone contributed considerably to the deepening of these imbalances. In the first section of the article a comparative analysis of the two groups of economies, i.e. the core and the periphery economies was presented. The analysis provided an undeniable proof of the broad range of the current imbalances and the fact that one of the targets set for the introduction of the common currency, i.e. the moderating of the macroeconomic imbalances, has not been achieved. In the second part of the paper the author presented the main causes of such significant differences between the member states. According to the author, these causes have their source principally in discrepant economic structures, uncoordinated fiscal policy and a varied progress as regards structural reforms implemented in the last decade. In the third part of the article the author proposed a number of changes that have to be implemented in order to modify the architecture of the Eurozone. Historical experiences in the realm of the monetary union functioning seem to confirm the thesis that a monetary union may not function efficiently unless it is accompanied by a parallel political union, to which there is sufficient historical testimony. The scale of the crisis which has hit the eurozone leads to the conclusion that no European country will be able to cope with it individually. The European Union, especially the euro area, needs an efficient management and greater integration. Economic divisions within the euro area countries may have a negative impact on the political cohesion of the euro area. Accelerated political integration seems to be a necessary measure to take. Without further political integration, economic integration, and particularly the maintenance and expansion of the monetary union, which is a key condition for integration today, are not possible. Currently observed phenomena in the eurozone go much further beyond the debt crisis. The monetary union is torn by internal contradictions arising from the crisis of the leadership, loss of confidence and difficulties defining its own identity: what is the eurozone today and what is it to become in the future?

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