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Macron at a rally in Chatellerault, France, April 28, 2017. Regis Duvignau/Reuters

Will a president Macron be able to reform the eurozone?

European financial markets are already betting on the victory of centrist French presidential candidate Emmanuel Macron in the country’s May 7 second-round election.

Are investors right to believe that the eurozone – the monetary union of countries that have incorporated the euro as their national currency – will gain new momentum with Macron in the Élysée Palace?

After all, Macron, who is strongly pro-European Union, has affirmed several times over the past year that “the Euro will fail in ten years without reform”, adding he would promote more and better eurozone governance.

The importance of the parliamentary elections

Ultimately, the political stance of the new French president vis-a-vis Europe will be heavily influenced by parliamentary elections in June, which will also determine the prime minister.

According to polls, some 40% of the French voters today take an anti-European stance.

Macron’s rival, the National Front’s Marine Le Pen, advocates unconditional rejection of Europe and the euro - even if she appears to have softened her stance on the common currency.

On the campaign trail, left-wing candidate Jean Luc Mélenchon and his supporters were also quite lukewarm towards the single currency even if they seemed at least willing to renegotiate in favour a different Europe.

If both the far-right and the far-left do well in the parliamentary elections in June, Macron, if elected, would face the task of imposing his views. Will he be able to initiate substantial reform of the euro area?

In the past, he has repeatedly advocated fiscal unity, and during his short term as economy minister he said that “he would like to set up a common eurozone treasury with a single finance minister.”

Macron would have to deal with the strong anti-European nationalistic backlash and the “Germanophobia” of Le Pen and Mélenchon’s supporters.

French Economy Minister Emmanuel Macron (L), French Finance Minister Michel Sapin (C) and German Finance Minister Wolfgang Schauble (R) at the Franco-German Economic and Financial Council 2016. Charles Platiau / Reuters

Whether he can achieve his vision will depend also on his ability to win support across Europe. His idea of a fiscal union may meet resistance there, especially when it comes to cross-border risk sharing, which Germany and other northern countries fear will leave them footing the bill.

An asymmetric monetary union

The current situation is informed by what happened to the eurozone as a result of its 2010 crisis. To deal with the sovereign debt crises of Greece and several other member countries, the EU arranged financial “rescue packages” conditioned on austerity measures and policy reforms.

Unintentionally, these actions changed the character of the eurozone – and ultimately also that of Europe – from a union of equals to an asymmetric currency area dominated by creditor-debtor relationships.

The creditor nations were perceived as imposing economic hardship on cash-strapped states, even as the former were contemplating transferring their own taxpayers’ money to reform-resisting neighbours.

The euro crisis quickly developed into a European political crisis. Today, debtor countries lament their loss of sovereignty and, in healthier nations, support for “European solutions” has rapidly diminished.

The crisis revealed that the eurozone is an incomplete monetary union and, as such, vulnerable to shocks that hit member countries differently.

Most economists agree on what could fix this problem: a central bank that can effectively backstop financial crises; a banking union with the three core elements of single supervision, a single resolution mechanism and single deposit insurance; and a fiscal union to facilitate risk sharing.

With respect to the central bank, the European Central Bank, is now doing “what it takes” as it pledged in 2012 , but the European banking union is still incomplete. This is largely because of resistance to a single deposit insurance, especially in Germany, which sees this guarantee as a form of debt mutualisation.

As long as European banks remain in peril, it’s German insurance contributions that would be transferred to cover bankruptcies of foreign banks.

Augmenting the banking union with a fiscal backstop will be a major task in the coming years, but it may be feasible provided Europe’s economic recovery continues and the banking sector undertakes sufficient restructuring measures.

This brings me to the crucial point: the fiscal union – the idea of a common European treasury, which could ultimately organise fiscal transfers between member countries.

Macron is very much in line on this with what most economists would - at least theoretically - recommend for making the incomplete monetary union work. But unfortunately, the political appetite for “more Europe” is at best marginal and good intentions could quickly fail in light of harsh political reality.

Still, one should not make the best the enemy of the good when feasible solutions are within reach. An alternative to the fiscal union is to give back control over national fiscal policies to the countries themselves and abandon various fiscal pacts altogether.

None of them has ever really worked in practice as the widespread violation of the EU deficit criteria shows. So it would better to let national governments decide on their budgets and give them back decisions on how to spend taxes.

After all, this is what is being voted on in European elections in general and the French election in particular. And the change would also answer the concerns of those who feel - for right or wrong reasons – that their national sovereignty is being impaired.

The four conditions for a stable Eurozone

But does that not mean that the euro area would remain vulnerable? Not necessarily.

As argued by leading economists Professor Barry Eichengreen (Berkely) and Charles Wyplosz (Geneva), four minimum conditions should be met to guarantee the stability of the monetary union in case of a return to national decision making on fiscal matters.

First, a central bank backstopping financial crises and, second, a full banking union. Both these conditions would form a good base for insuring against asymmetric shocks. A full banking union in particular, would allow private risk sharing through better integrated financial markets, which could cushion the effects of such shocks.

Third, giving back control to national governments also implies giving back responsibility. In other words, a strict no-bailout rule is needed and may even be more effective for imposing more budget discipline.

Finally, giving back control to nations requires reducing debt overhang. This may be the hardest part, as “moral concerns” in some countries may oppose workable debt restructuring schemes – but it would not be impossible either.

Re-nationalising fiscal policy could therefore offer a politically feasible alternative to a full fiscal union as a way of stabilising the euro area. It should be noted, though, that this neither implies not engaging in joint European infrastructure projects nor abstaining from assistance programs for individual countries.

Such initiatives may, in fact, be easier to implement once unpopular and ineffective fiscal rules are a thing of the past.

A president Macron might thus wish to rethink his earlier view on a fiscal union.

Reforming the euro area is a real possibility. The ultimate issue is not whether we need more or less Europe but rebalancing eurozone governance in a direction that is both politically palatable and provides much-needed stability for the European monetary union.

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