Monetary union making its members more resilient

There are many ways in which countries benefit from close financial interrelationships. For instance, investors can buy shares in solar energy firms in sunny Spain while at the same time investing in Norwegian water power plants in order to hedge against potential losses on each investment. This is what experts refer to as a more efficient allocation of capital and enhanced diversification of risks.

However, economists also frequently discuss the potential disadvantages of close financial ties between countries. The consequences of the US Federal Reserve Board’s accommodative monetary policy for emerging market economies such as Brazil or India are a case in point. The Fed eased its monetary policy stance in response to the financial crisis, thus making it more attractive for investors to invest in emerging markets in anticipation of higher interest rates. The sudden surge of capital caused these emerging markets’ currencies to appreciate, however, thus reducing their competitiveness. Experts assume that such developments can quickly cause damage to small, financially highly interconnected economies, in particular.

European monetary policy can exert global influence

Against this backdrop, the Bundesbank’s economists studied the situation of the euro-area countries, also taking into account the recent financial crisis. Their conclusion is that the monetary union has made its members stronger in the global financial environment and more resilient to global financial shocks. They see the size of the European monetary union as one reason, noting that "... the single European monetary policy is certainly capable of influencing global monetary developments". Without the union, the economies of some individual euro-area countries would represent relatively small constituents of the international financial system.

An empirical study cited by the article in the Monthly Report shows that euro-area countries are better able to withstand financial shocks because commercial banks in all member countries can always tap the Eurosystem for funding. Although commercial banks in some countries had a harder time acquiring funding on the interbank market in the recent financial crisis, the banks affected could make up for this by obtaining sufficient liquidity through the Eurosystem’s open market operations. The terms and conditions for these operations are the same for all participating credit institutions in the Eurosystem, irrespective of their country of domicile or nationality.

Banks increasingly borrowing from the Eurosystem

However, the economists also see drawbacks to this protective function of the single currency. The generous supply of liquidity via the Eurosystem in the aftermath of the recent financial crisis drove real wages in some euro-area enterprises so high that these firms would no longer be competitive if funding costs were to go back up. The Bundesbank’s economists therefore warn that "being shielded from abrupt reversals of capital flows can delay necessary real wage adjustments". A transfer of risk from the private sector to the Eurosystem is viewed as a further disadvantage of the provision on equal terms of liquidity by national central banks: those banks that are able to obtain funds on the private capital markets only at unfavourable terms and conditions increasingly borrow from the Eurosystem.

The Bundesbank’s economists believe that member states should now use the leeway that the monetary union’s protective role affords them to safeguard financial and macroeconomic stability through an appropriate policy mix of sound public finances and effective financial sector regulation. They also expect positive stimulus from the European capital markets union, which involves plans to create an integrated capital market by 2019. "Establishing a European capital markets union may help to further increase international risk sharing based on market mechanisms whilst also creating incentives for more efficient economic structures", according to the report.