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Delivering the Eurozone ‘Consistent Trinity’

Although progress has been made on resolving the Eurozone crisis – vulnerable countries have reduced their current-account deficits and implemented some reforms – more still needs to be done. This column argues for a ‘consistent trinity’ of policies: structural reforms within countries, more symmetric macroeconomic adjustment across countries, and a banking union for the Eurozone.

As argued in an earlier commentary, the financial crisis exposed important economic inconsistencies in the way that EMU operated.1 Although progress has been made, the reality is that more needs to be done. A number of countries still need to consolidate their public finances further, and also implement structural reforms to promote growth and sustain satisfactory welfare systems. At the same time, there is a need for vulnerable countries to ensure consistency between regaining competitiveness and the sustainability of private and public debts. Finally, overcoming financial fragmentation is a sine qua non for promoting financial stability while ensuring the effective flow of funds across the monetary union. The institutional/policy mix that addresses these problems comes in the form of a ‘consistent trinity’ that involves: (i) deep fiscal and structural reforms within countries, (ii) a rotation of demand that contributes to a more symmetric adjustment across countries, and (iii) a banking union at the level of the Eurozone as a whole.

The Commission is delivering its part of the consistent trinity. As the European Parliament, Council, and Commission reach important agreements on the banking union, the Commission has been monitoring progress made by countries in terms of the two first aspects of the consistent trinity.

Changing challenges: structural reforms and rotation of demand

Integrated surveillance of fiscal and structural issues

On the fiscal field, the Commission is implementing the reformed Stability and Growth Pact, and ensuring that the appropriate fiscal efforts are effectively delivered by each country. After the analysis (for the first time) of the draft budgetary plans prepared by the Eurozone governments in autumn 2013, a continuous monitoring of developments led the Commission to address formal recommendations to France and Slovenia on 5 March 2014, as risks have accumulated that these two Member States could fail to reach their headline and structural targets. Moreover, the Commission has published ‘in-depth reviews’ (IDRs) carried out for 17 Member States, under the Macroeconomic Imbalance Procedure, which is the new coordination process introduced in 2011 in the aftermath of the financial crisis.2 The IDRs focus on the structural features of the economies which may constitute imbalances and generate macroeconomic risks and harmful spillovers.

Structural reforms for competitiveness and sustainability

The overarching theme of this year’s IDRs is that the nature of the challenges Eurozone countries face is changing. Just a few years ago, the main policy issues related to unsustainable current-account deficits, worrying losses in competitiveness linked to very dynamic labour costs, increasing private debts, and high housing prices. The main challenges of a cross-country nature now concern the lingering impact that deleveraging pressures in many countries have on medium-term growth, the sustainability of private and public debts in a context of competitive disinflation, and the need to provide credit to viable investments in the vulnerable economies, under a convalescent financial system.

Figure 1 shows that unsustainable current-account deficits have been corrected (see Spain and Portugal in the left-hand panel, but similar developments also took place in Ireland, Greece, and Slovenia). However, the figure (right-hand panel) also shows that while flows have adjusted, the stocks remain problematic for the peripheral countries that are left with a large debt overhang. The dichotomy between ‘deficit countries’ and ‘surplus countries’ has been replaced by one between ‘net debtors’ and ‘net creditors’. In order to reduce their debts and the burden that they cause in terms of negative income flows, the peripheral countries will have to run current-account surpluses for several years – the ongoing reorientation of the productive system towards exports and the recovery in competitiveness will have to be maintained. From a policy perspective, this emphasises the need to continue with structural reforms to spur real growth and facilitate the reallocation of labour and capital to the tradable sectors.

Figure 1. External rebalancing in the Eurozone: stocks and flows

Countries in unfavourable competitive positions prior to the crisis have engaged in internal devaluations, which have led to very low inflation or even reductions in their domestic prices. However, the pace of internal devaluation needs to be made consistent with debt sustainability, since low nominal growth may conflict with the need to reduce private and public debt ratios, while the reduction in wages compresses domestic demand. Figure 2 illustrates this, as the countries with lower inflation (and nominal GDP growth) given the initial competitiveness position are those with higher debts and facing higher financing costs.3 Over and above this, an environment of persistent low inflation across the Eurozone – below the ECB’s definition of price stability of an inflation rate below, but close to, 2% – makes the relative price adjustment between countries, which is so necessary to the peripheral countries, all the more difficult. Moreover given nominal rigidities, a persistent very low inflation might also be a hurdle to the necessary adjustments in real wages, which has important consequences for employment and unemployment.

Figure 2. Low inflation and debt

Source: Eurostat, AMECO.

Notes: The x axis is Net International Investment Position (NIIP) multiplied by -1, i.e. positive numbers reflect debt. NIIP value of 2013Q3, except FR and MT (2012Q4), and IT (2013Q2). Inflation based on EC Winter forecast for 2014.

Structural reforms for investment, rotation of demand, and symmetry in adjustment

The correction of the large current-account deficits means that, since creditor countries are not adjusting sufficiently, the Eurozone is registering a large and increasing current-account surplus. The risks arising from such a surplus are the strain on domestic demand and therefore on the ability of the Eurozone to grow, but also the possibility of a euro appreciation that could erode peripheral countries’ efforts to regain competitiveness. Preventing this from happening is very important for the peripheral countries themselves, but also for the Eurozone as a whole.

Appropriate reforms in core countries and a greater symmetry in adjustment would be good for stimulating domestic demand in the creditor countries, as well as in the whole Eurozone, and facilitate the periphery’s efforts to restore competitiveness and to grow. Policies that contribute to an increase in investment are particularly critical, as they boost demand in the short term and increase potential growth in the future.

Buti and Padoan (2013) show how the reform dynamism has paid off in terms of potential growth, and therefore contributed to sustainable and long-lasting gains. In turn, higher potential growth contributes to the sustainability of private and public deft, and protects welfare systems in times of fiscal consolidation. Figure 3 shows that the reform dynamism and responsiveness to policy recommendations have differed among the Eurozone countries, with progress registered by the vulnerable countries, where the need was acute, but much less so by the largest or core Eurozone economies.

Figure 3. Responsiveness to policy recommendations across the Eurozone, 2011–2012

Source: Adapted from OECD (2013).

Eurozone governance coming of age

The Commission’s integrated analysis has acknowledged the important progress made in a number of countries, but also clarified the changing nature of the challenges remaining. In its third year of operation, the Macroeconomic Imbalance Procedure as a new governance tool, has allowed granularity and greater differentiation in the way countries are evaluated – discussing both the remaining competitiveness issues in the periphery and drawing attention to the inefficiencies that are behind the large external surpluses in the core. The country assessments are based not only on a snapshot of their present economic position, but also on the country’s dynamics and interaction within the monetary union. In addition, the analysis takes into account the country’s capacity to adjust and efforts made to implement necessary policies.

The Commission’s approach has allowed an assessment of how macroeconomic risks and imbalances have evolved. In the case of Italy, the risks are deemed higher than last year, leading to the identification of ‘excessive imbalances’. The opposite result has been identified for Spain and Ireland, where reforms have contributed to the reduction of existing risks and the successful completion of their programmes supported by international financing. The Commission surveillance has discussed country-specific inefficiencies, such as low levels of investment (Germany) or losses in competitiveness (France), but also what their synthesis implies for the Eurozone as a whole.

In the middle of a broadening but still fragile recovery, a boost to economic activity and the medium-term outlook is expected to come from continuing structural reforms aimed at boosting competitiveness and adjustment in the vulnerable economies. For the larger and less indebted Member States, policies to increase demand and potential growth would provide both benefits domestically and ensure greater symmetry in adjustment. Among the largest Eurozone Member States, the policy priorities should be on: strengthening domestic demand, including investment, and medium-term growth in Germany; addressing bottlenecks to medium-term growth while working on structural reforms and fiscal consolidation in France and Italy; and continuing the orderly deleveraging and structural transformation of the economy in Spain that will contribute to sustainable growth, while addressing social issues.

At the Eurozone level, progress on the banking union, including the asset quality review and the stress tests, is crucial to minimise the feedback loops between banks and sovereigns, restore confidence in the banking system, and tackle financial fragmentation in the Eurozone. The current benign market conditions should not lead to the relaxation of reform efforts, as happened all too often in the past.


1. Buti (2014). See also Pisani-Ferry (2012), among others.

2. See European Commission (2014). This is the second step in a three-step process. The first step starts with the Alert Mechanism Report (COM (2013) 790 of 13 November 2013) in the autumn that decides for which countries an in-depth review will be carried out. The third step comes in June when the Commission issues Country Specific Recommendations following countries’ submissions of their national reform and stability programmes; these Recommendations will then be adopted by the Council.

3. See Merler and Pisani-Ferry (2012).


Buti, M (2014), “A consistent trinity for the Eurozone”, VoxEU.org, 8 January.

Buti, M and P C Padoan (2013), “How to make Europe's incipient recovery durable – A rejoinder”, VoxEU.org, 8 October.

European Commission (2014), “IDR Macroeconomic Imbalances, 2014”, European Economy – Occasional Papers, 172–188.

Merler, S and J Pisani-Ferry (2012), “The simple macroeconomics of North and South in EMU”, Bruegel Working Paper 740.

OECD (2013), Economic Policy Reforms 2013: Going for Growth.

Pisani-Ferry, J (2012), “The euro crisis and the new Impossible Trinity”, Moneda y Credito, 234.

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