The European Economic Union

The European Economic Union

Introduction

When the US subprime mortgage crisis erupted in the summer of 2007, few people expected that it could affect the entire world economy so quickly and so drastically. One year later, there was no doubt that we were facing a financial crisis on a global scale with dramatic macroeconomic and social consequences for many regions and countries. This includes the entire European Union and the countries in its closest neighborhood (EU actual and potential candidates, CIS, Middle East and North Africa). The global financial crisis has also brought new challenges to European integration and the EU institutional architecture. The EU integration project, which has been progressing successfully for more than half a century, is now facing what is likely to be the most serious sustainability test in its history (Vives, 2009).

In particular, this relates to such crucial components as the Single European Market and the Economic and Monetary Union (EMU). The roots of the tensions that have appeared since the late summer of 2008 can be attributed to the incomplete nature of the EU project and its various asymmetries. Generally speaking, economic integration has advanced much faster than political integration. More specifically, fiscal capacity at the Union level, which is crucial for responding to the crisis, is very limited, and the coordination of national fiscal policies and policy interventions involving national budgets has met with numerous obstacles.

This paper's main objective is to provide an early attempt to analyze the challenges mentioned above in various policy spheres, with special attention given to fiscal constraints in conducting effective joint crisis management at the EU level. Where possible, I suggest policy responses or at least the direction they should take.

Discussion

Europe's response to the crisis came quite late and not always in a well-coordinated way. In its first phase (until the late summer of 2008), the danger of systemic financial crisis was downplayed by most policymakers. The periodic liquidity squeezes on the inter-bank market were considered a temporary contagion effect imported from the US. The main policy concerns were the appreciation pressure on the Euro (generated by a depreciating US dollar), the weakening US demand for EU export, the continuing inflationary pressure and the decline of the housing market in some EU countries.

The breaking point came with the Lehman Brothers bankruptcy in mid-September 2008. This dramatic event triggered a far-reaching contagion effect on world financial markets and global financial disintermediation. Several segments of the global financial system, for instance inter-bank lending, stopped working. As a result, the money multiplier decreased dramatically.

This phase of the crisis revealed many systemic weaknesses of the European financial institutions, whose state of affairs did not differ so much from their US partners and competitors. It became apparent that European banks and other financial institutions were also heavily exposed to various “toxic” assets, which originated both domestically and were acquired in the US, and were overleveraged (Veron, 2007).

The policy responses were quite chaotic and mostly on a national level, in spite ...