Eurozone: Still under construction

The never-ending power struggle between national interests and European influence has been reflected in every discussion about bailout packages, fiscal rules, structural reforms and now, more prominently, in the discussion on the right way forward for the monetary union.

Some argue that this issue can never be resolved, and with the rise of populist parties, the conflict has become tougher and the fight nastier.

In the coming months and years, sluggish economic growth could easily reinforce these tensions. A sharp recession would probably force all eurozone governments to implement fiscal stimulus, thus limiting the damage. But a longer period of sub-potential growth could prove more dangerous.

Citizens in Southern Europe are already tired of austerity measures and structural reforms. And the situation in core eurozone countries is unlikely to be severe enough for governments to act while the adverse effects of further monetary easing (lower interest rates undermining savings and pensions) would probably play into populist hands. In our view, the EU will have to face two fundamental questions:

1) For the core countries, it is increasingly clear that saying no to looser fiscal rules and a significant eurozone budget would push the ECB into even more easing.

2) For the more Southern eurozone countries, asking for support and solidarity without giving away national sovereignty also looks like a dead-end street.

For both sides, something will have to give

Widening gaps between the haves and have nots could accelerate these tensions. Recent decisions by the ECB, as well as the controversy surrounding Italian fiscal policies, suggest that cracks are already beginning to show.

While there are, of course, other factors at play that will determine the success or failure of the monetary union, in this report we focus squarely on the economics to take stock of where we stand ahead of yet another crucial euro summit.