Europe’s Historic Gamble

BERKELEY – The last few weeks have been the most amazing – and important – period of the euro’s 11-year existence. First came the Greek crisis, followed by the Greek bailout. When the crisis spread to Portugal and Spain, there was the $1 trillion rescue. Finally, there were unprecedented purchases of Spanish, Portuguese, Greek, and Irish bonds by the European Central Bank. All of this was unimaginable a month ago. Europe’s fortnight mirabilis was also marked by amazing – and erroneous – predictions. Greece would be booted out of the monetary union. The eurozone would be divided into a Northern European union and a Southern European union. Or the euro – and even the European Union – would disintegrate as Germany turned its back on the project. But, rather than folding their cards, European leaders doubled down. They understand that their gamble will be immensely costly if it proves wrong. They understand that their political careers now ride on their massive bet. But they also understand that they already have too many chips in the pot to fold. Those forecasting the demise of the euro were wrong because they misunderstood the politics. The euro is the symbol of the European project. Jacques Delors, one of its architects, once called the single currency “the jewel in Europe’s crown.” Abandoning it would be tantamount to declaring the entire European integration project a failure. It is true that Germans are incensed about bailing out Greece. It is true that Angela Merkel is the first postwar German chancellor not to have lived through World War II. But her views and actions are shaped by the society in which she lives, which in turn is shaped by that history. And what is true of Merkel is still true of Europe. This is why European leaders swallowed hard and took their unprecedented steps. But, having doubled their bet, Europeans now must make their monetary union work. Europe has excellent bank notes. It has an excellent central bank. But it lacks the other elements of a proper monetary union. It needs to establish them – and fast – which requires finally addressing matters that have been off-limits in the past. First, Europe needs a Stability Pact with teeth. This will now happen, because Germany will insist on it. As the European Commission has proposed, the strengthened pact will have tighter deficit limits for heavily indebted countries. Exceptions and exemptions will be removed. Governments will be required to let the Commission vet their budgetary plans in advance. Second, Europe needs more flexible labor markets. Adjustment in the United States’ monetary union occurs partly through labor mobility. This will never apply to Europe to a similar degree, given cultural and linguistic barriers. Instead, Europe will have to rely on wage flexibility to enhance the competitiveness of its depressed regions. This is not something that it possesses in abundance. But recent cuts in public-sector pay in Spain and Greece are a reminder that Europe is, in fact, capable of wage flexibility. Where national wage-bargaining systems are the obstacle, the European Commission should say so, and countries should be required to change them. Third, the euro area needs fiscal co-insurance. It needs a mechanism for temporary transfers to countries that have put their public finances in order but are hit by adverse shocks. To be clear, this is not an argument for Germany’s dreaded “transfer union” – ongoing transfers to countries like Greece. It is an argument for temporary transfers to countries like Spain, which balanced its budgets prior to the crisis but then was hit by the housing slump and recession. It is an argument for fiscal insurance running in both directions. Fourth, the eurozone needs a proper emergency financing mechanism. Emergencies should not be dealt with on an ad hoc basis by 27 finance ministers frantic to reach a solution before the Asian markets open. And European leaders, in their desperation, should not coerce the European Central Bank into helping. There should be clear rules governing disbursement, who is in charge, and how much money is available. It should not be necessary to obtain the agreement of 27 national parliaments each time action is needed. Finally, Europe needs coherent bank regulation. One reason the Greek crisis is so difficult is that European banks are undercapitalized, overleveraged, and stuffed full of Greek bonds, thereby ruling out the possibility of restructuring – and thus lightening – Greece’s debt load. That happened because European bank regulation is still characterized by a race to the bottom. “Colleges” of regulators, the supposed solution, are inadequate. If Europe has a single market and a single currency, it needs a single bank regulator. This is a formidable – some would say unrealistically ambitious – agenda. But it is the agenda Europe needs to complete to make its monetary union work. Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley. Copyright: Project Syndicate, 2010. www.project-syndicate.org