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For a year European policymakers have been busy fixing bugs in the design of Economic and Monetary Union. As with defective software, successive new versions of EMU have been introduced at a frantic pace – only to discover remaining vulnerabilities shortly afterwards. In spite of last-minute hiccups and disagreements over details, they claim this time to have come up with an enhanced, bug-free new version – a sort of ‘EMU 2.0’. Can we now trust it?

The starting point for a review is where troubles came from: the crisis prevention regime. Before 2010, it was almost entirely based on the surveillance of budgetary deficits within the framework of the Stability and Growth Pact (there was also a procedure for economic surveillance, but it had no traction). The crisis revealed major problems with enforcement of this framework, but also with its design. No light ever flashed red to indicate that Ireland or Spain were in danger.

The new regime will take into account the debt ratio (so that Italy will not be able to keep it at such as high level) and implicit liabilities (so that a country with an oversized banking sector will have to factor in potential rescue costs). Decisions on sanctions will be streamlined by a reverse majority rule. All this is encouraging.

A second plus is the recognition that not all crises are rooted in a lack of budgetary discipline. It is now agreed that financial stability and macroeconomic stability also matter. But the new policy framework looks somewhat unclear. There will be no less than three different, partially overlapping, European procedures – for budgets, macroeconomic imbalances and macro-financial stability. Clumsy intergovernmental processes risk blurring priorities, confusing policymakers and exhausting civil servants.
For this reason it is to be feared that the governance model will soon be in need of reform and that the EU will have to decide where to rely more on reformed national frameworks and where to allocate more responsibility to Brussels. The new emphasis on national budgetary rules is a welcome first step – but only a first step.

For crisis management and resolution there was nothing to reform, because nothing existed. A new pillar has now been added to the edifice. Agreement to create both a liquidity provision facility and an insolvency procedure has implied revisiting fundamental principles – not least the no bail-out clause. EMU will now be equipped with the ability to provide assistance to a country cut off from market access but also to organise the restructuring of its public debt. This shows an ability to reform and learn from experience.
The new regime is, however, not without defects. First, it is strange that Europe has agreed to provide assistance only as a last resort, by unanimity and with harsh conditionality, at a time when the IMF has created first-resort, near-automatic and low-conditionality facilities to help countries hit by sudden capital outflows. There is a risk that the European framework will create an avenue for speculation. Second, the EU has taken the least legally difficult route to debt crisis resolution, the so-called contractual approach which aims at facilitating agreement with private creditors. But the most contentious part risks being agreement with the governments of partner countries. A formal legal procedure would have helped.

When a new version of a piece of software is introduced, users often experience incompatibility with files created with the older one. Here also, transition to the new regime may prove difficult. Even abstracting from Portugal, several problems still await a solution. There is an urgent need to expedite the resolution of the banking crisis, for which credible and comprehensive stress tests is an indispensable first step. Foot-dragging – not least by Germany – prevents the return of confidence. There is an equally important need to sort out state insolvency cases from illiquidity cases. Greece is likely to find itself insolvent and there are questions about Ireland and Portugal. Again, confidence will only return after an answer is given. Third, markets need to understand what will happen if some sort of debt restructuring takes place before the permanent regime is introduced in 2013. Fourth, the ECB needs to know how it will get rid of the peripheral bonds on its balance sheet. And last but not least, the EU still has to come up with a strategy to revive growth in southern Europe.

So the outcome of months of discussion is probably better characterised as EMU 1.7.3 rather than EMU 2.0. More bugs will have to be fixed, including in the new fixes. This reform process may seem impossibly long and hesitant by market standards. This should not hide the fact that it has been exceptionally fast by the standards of international negotiations and European governance.