How can the EMS crisis of 1992-93 crisis help the Eurozone today? Part 2

In my previous post I began by drawing some similarities between the EMS currency crisis of 1992-3 and the current Euro zone crisis today. This piece is a continuation of that discussion. I shall be elucidating further details on the EMS and shedding further insight on how the damage from the current crisis could have been reduced significantly.  

The Cypriot banking system not fared well throughout this episode.
The Cypriot banking system not fared well throughout this episode.

The Delors report draws similarities to the Werner Plan[1] of 1969. Both proposals advocated for the idea of a united European union that would allow the movement of capital and labour to move with considerable ease, which in turn would be facilitated by the adoption of a common currency. Both documents are therefore imperative to the realization of the EMU. The current crisis in the Euro zone highlights some of the shortcomings of the proposals. Some of the recommendations that were encouraged in the Delors report could be viewed as potential reasons as to why the Euro zone is in a precarious position today. Firstly, the Delors report suggested the establishment of a European System of Central Bank (ESCB). Although it was and remains an exogenous agent of the European economic system, the similarities of other central banks stops there. Arguably, one of the most critical features of most a central banks is the fact that most central banks are the lender of last resort. The current Euro zone crisis has highlighted what can now be viewed retrospectively as a limitation within the Delors proposal. French monetary authorities have argued that the current Euro zone crisis could be aided significantly if the ESCB could buy Euro zone debt.

“The best way to avoid contagion in countries like Spain and Italy is an intervention or an announcement that a lender of last resort could intervene.” (Baroin 2011)

German authorities are notoriously opposed to debt monetization because of the inflation and therefore potential hyperinflationary pressures it could bring to the common currency. Therefore, the current crisis is a reflection that the ESCB do not have enough monetary control the deal with a crisis of this magnitude.

Both monetary and fiscal harmonization was not only a goal; it was a necessity if European ministers were to achieve their aim of a closer economic zone. If one is to critically assess the Delors report, it could be argued that there may have been too much of an emphasis on monetary integration and evidently not enough focus on fiscal integration. The Maastricht Treaty[2] however identified the need for fiscal stability within Europe and the Stability and Growth Pact (SGP) made several recommendations in order to promote both monetary and fiscal stability. Dimitri Syrrakos suggests that the SGP would prevent nations from needlessly resorting to certain monetary policies that could undermine the creditability of the common currency

“Once the countries were eligible to participate in the single currency they would not resort to policies based on monetary laxity, as this would damage the credibility of the new currency.”

The intentions of the SGP were understandable; any union that would amalgamate several contrasting economies needed a stringent fiscal framework in order for it to function appropriately. If we analyse the current EMU crisis, the authenticity of the SGP is in question because strict sanctions were to be imposed on any nation who did not adhere to the ‘strict’ conditions set by the EU. If this were the case then several nations including Germany, Italy and Greece in particular would have been punished appropriately for their fiscal mismanagement. Former UK Prime Minister John Major speaking to the Financial Times in November 2011 suggests that:

“Southern states over indulged on low interest-rates and racked up debts. When Germany and France over-stepped the criteria without any penalty by the commission, the criteria became toothless.”

It is fair to suggest with hindsight that sanctions on nations who had failed to abide by the framework set by the EMU would have almost minimalised the severe economic damage that has beset the Eurozone today. Had sanctions been imposed some ten years ago, or even five, then the severe problems that appear only to be appearing now could have been dealt with then.

 GDP to debt ratio (%) 2007-2010









































With regards to the realization of the EMU, the SGP was implemented in 1997, ten years before the data range in the table. Despite a prerequisite of national debt being less than 60% of GDP levels, the table highlights the inability of Euro zone members failing to deal with nations not following the fiscal framework. This tacit failure to impose sanctions on members allowed certain members continue to let national debt to grow until it became an apparent and uncontrollable problem, hence, the systemic failure of the system itself. Clive Cook is one of several commentators who have critical views on not only the SGP, but of EU governance in general,

Remember the EU’s vaunted Stability and Growth Pact of 1997, which supposedly put limits on public borrowing — and which Germany, by the way, violated? The same syndrome is evident today. Write a new rule now, worry about enforcing it later. This has been the hallmark of EU governance.”

Moreover, this has been a consistent theme that has underpinned EU and Euro zone governance. Despite apparent mechanisms being in place to prevent severe economic shocks, Euro zone nations appear to have repeated the same systemic errors, the only difference with the EMS crisis of 1992 and the current crisis is the severity, the current crisis however appears to be of a much greater magnitude.

The fundamental aim of the EMU was to integrate several economic zones, politically and more importantly economically in order to reduce exchange-rate uncertainty and provide a zone of cohesion as opposed to a network of conflicting monetary and fiscal interests. A solution to the current Euro zone crisis is not only the desire of policy makers, but it is a fundamental requirement because if the Euro zone were to collapse, the consequences would be catastrophic. Fiscal harmonization is required if the current Euro zone crisis is to be resolved, this was the case following the collapse of the EMS. The EMU may be politically viable because it has increased European integration, economically however it may appear no more than a ‘utopian’ idea. Dinan suggests the necessity of EMU was “debatable on economic grounds.” (Dinan 2005). Following the failure of the EMS, ministers appeared to recognize the errors that had damaged the economic system, and, policy appeared to identify the errors that had damaged the European economy. What is ironic about the current crisis is that there are a number of policy issues designed to prevent the problems that realistically could destroy the entire EMU or even the EU. Had the SGP rules been implemented, the problems that have only come to fruition in the last two years or so would have been tackled. The Euro zone crisis is an extraordinary economic crisis, whatever the outcome, European economics will never be the same again.

[1] The Werner Plan could be seen as the prerequisite of the Delors report of 1989. They share similar themes and raise a number of concurrent issues, however, the adoption of the Werner plan’s proposals and subsequent dismissal in 1973 does suggest that Europe was not ready to adopt such proposals.

[2] The Maastricht treaty was based on the Delors Report and the main objective was to complete the market integration with the creation of the common currency.