Professor John McHale:

I thank the committee for the opportunity to appear before it today. This statement provides some introductory reactions to the report of the four Presidents of the EU and also the European Commission's blueprint report. These documents set out an ambitious, staged project for the development of economic and monetary union, EMU. The vision is a combination of strengthened disciplines to limit adverse spillovers between member states and improved supports to improve stability and enhance convergence. The Commission's blueprint is the more ambitious document, with a greater focus on necessary crisis resolution tools. While the documents are very welcome contributions given the magnitude of the growth and employment challenges, there is a concern that they, and especially the four Presidents' report, focus too much on disciplines relative to supports and too much on supply to the neglect of demand.

On fiscal integration, significant steps have already been taken to improve structures for fiscal discipline with the six pack, fiscal compact and, most recently, the two pack. With Ireland's debt projected to peak this year at an unsafe 123% of gross domestic product, GDP, we have no choice but to reduce our deficit and debt. The new disciplines reinforce and make more credible a direction in which we have no choice but to go. However, the crisis has revealed the fragility of a country's debt sustainability and associated access to borrowing within the monetary union even at lower debt levels. The new crisis resolution tools, notably the European financial stability facility, EFSF, the European Stability Mechanism, ESM, and the European Central Bank, ECB's, outright monetary transactions, OMT, programme, have been significant steps forward. These steps have been hesitant, with the early proposals for the design of the ESM undermined by threats of a low trigger for private debt restructuring and official creditor seniority. While the announcement of OMT has had a significant impact on bond yields, the adequacy of the design has yet to be tested.

The proposals for a central fiscal capacity and associated stabilisation fund offer the potential for improved shock absorption capacity, especially if the fund has a capacity to borrow. These proposals are envisioned as a longer-term reform and not as part of the policy arsenal to resolve the current crisis. However, more and faster action may be needed. While it is understandable that there is resistance to a risk sharing debt redemption fund, DRF, and eurobills that were included in the Commission's proposals but not in the four Presidents' report, the revealed fragility of creditworthiness within the monetary union suggests the need for bolder action to prevent self-fulfilling runs on sovereign debt in vulnerable countries.

With regard to banking integration, the crisis revealed deep flaws in national level regulation and supervision of banks and also the potential for vicious feedback loops between banks and sovereigns where banks remain a national responsibility. The plan for a staged process to a European banking union is thus a welcome development. The envisioned end point is a US style, least-cost bank resolution process, with clear priority for loss absorption running in the order of equity to junior bonds, to senior bonds and finally to uninsured deposits. The recent Cyprus experience shows that elements of this model can be brought in on an accelerated basis. The envisioned system would be backed up by a European resolution fund, funded by risk based levies on banks, a capacity to borrow, possibly from the ESM, and ex post risk-based levies to repay such borrowings. Deposit insurance would remain a national responsibility, although the design of national systems would be harmonised.

This system offers an improved end point in terms of minimising moral hazard and sovereign risks. However, with parts of the European banking system still under significant capital and funding stress, care must be taken in the phasing in of the new system so as not to impair further credit availability in the heavily bank-reliant euro area economy. While strengthening the claims of insured depositors, least-cost resolution will make other creditors more wary of providing funding to banks and more prone to flee at early signs of trouble. The tougher resolution framework will need to be complemented by a stronger focus on ensuring banks are adequately capitalised, backed up by rigorous stress tests and ESM involvement in ensuring adequate capital levels where necessary.

On economic integration, in its response to weak growth and high unemployment, the plan envisions efforts to further the development of the Single Market and structural reforms to improve supply-side performance. There are plans for greater co-ordination of structural reforms where the policy changes have potential spillover effects on other members. One promising element is the convergence and competitiveness instrument,CCI, whereby member states enter into contractual arrangements for well-defined structural reforms in return for financial support. Sometimes it appears that European policymakers see the solution to Europe's weak growth as being only on the supply side. While well-designed structural reforms can bring significant benefits, the process can be difficult and slow, with the impact effects sometimes being negative. In the case of labour market reforms, a recent review by the International Monetary Fund, IMF, of its policy advice in this area noted: "An important branch of research has focused on the cross-country evidence regarding the effects of specific labor market institutions on the unemployment rate. .. This research has reached two broad conclusions: The devil is in the details (and the details are hard to capture in the rough measures of institutions used in regressions); and the combination of institutions matters very much."

With the ECB's single mandate for price stability and the rules of the Stability and Growth Pact, SGP, focused on national level policies, tools are lacking for aggregate demand management in the euro area as a whole, even if the flexibility present in the SGP is sometimes under-appreciated. The co-ordination potential of the European Semester process could be better used to ensure an appropriate aggregate stance of euro area fiscal policy. This should be focused in particular on stronger countries that retain the so-called fiscal space for more stimulative policies. Given the depth and nature of the recession, Europe may be poorly served by what at times appears as a single minded supply side focus. In sum, the proposals in the reports set out an ambitious and necessary agenda for the effective functioning of EMU. Care must be taken, however, that understandable concerns about moral hazard and structural impediments to growth do not overwhelm the emerging design.