By Nick Mann | 22 June 2012
The eurozone is under acute stress and needs to make an immediate forceful move towards full monetary union, the International Monetary Fund said last night.
In a statement issued at the end of its annual review of the single currency bloc’s economic situation, the IMF said a ‘strong commitment’ towards a banking union and closer fiscal integration would help to restore faith in the euro.
‘Downward spirals between sovereigns, banks and the real economy are stronger than ever. As concerns about banks’ solvency have increased – because of large sovereign exposures and weak growth prospects in many parts of the euro area – the effectiveness of liquidity operations has diminished,’ it said.
‘Sovereigns, in turn, are struggling to backstop weak banks on their own. [In the absence of] collective mechanisms to break these adverse feedback loops, the crisis has spilled across euro area countries.’
Further intensification of the crisis could have a ‘sizeable’ effect on the rest of the world, particularly on non-eurozone European Union economies, the IMF said.
The immediate priority should be to take concrete steps towards a banking union, which would help break the link between domestic banks and the countries they are based in. This would help to guarantee and encourage savers about the security of their deposits. Such a union was ‘desirable’ for the European Union as a whole, but ‘critical’ for the eurozone, it added.
Closer fiscal integration was also needed to share the risk of financial shocks, and make it less likely that one country’s problems would jeopardise the eurozone as a whole. ‘Ultimately, this could mean sufficiently large resources at the centre, matched by proper democratic controls and oversight, to help insure budget shortfalls at the national level,’ the IMF said.
To begin this process, countries should commit to a ‘broad-based dialogue’ about what closer fiscal union would mean for their sovereignty and for the accountability of any central authority.
Looking more broadly at the need to stimulate economic growth, the IMF said that, in the short term, countries should adopt flexible fiscal consolidation efforts that help to support demand in the eurozone. The European Central Bank should also consider cutting interest rates and channelling support directly to ailing banks.
‘Recapitalisation of weak banks – including through direct support from European Financial Stability Facility/European Stability Mechanism resources – will help break the adverse feedback loops between sovereign and banking stress at the national level,’ the IMF said.
In the longer term, major structural adjustments were needed to encourage growth. Countries should reform their labour markets to increase employment and bring younger workers out of low-wage, temporary jobs.
They should also make ‘targeted investment in infrastructure and human capital to support growth and employment’.
The IMF’s recommendations came as the leaders of France, Germany, Italy and Spain were scheduled to meet today to discuss the continuing eurozone crisis. Their meeting comes ahead of a full summit of EU leaders being held in Brussels next week, where efforts to develop a full fiscal and banking union are expected to dominate the agenda.
