Spring 2011

How to Save the Euro

– The Wilson Quarterly

Every broke country is broke in its own way. With such different causes, what can the European Union do to mitigate the effects of economic crisis?

Every broke country is broke in its own way. At least that’s true of the European countries that have come to the brink of default since the global financial crisis unleashed waves of economic panic. In Greece, the cause was a love affair with “enormous, unsustainable government budget deficits.” In Ireland, it was large homes and a real estate bubble that dwarfed that of the United States. With such different proximate causes, what can the European Union do from on high, “beyond encouraging member states to tend to their gardens”?

It can begin by examining one commonality: At base, both countries were experiencing credit booms that began in 2002, just three years after the introduction of the euro. (Seventeen of the 27 EU member countries have embraced the euro.) European technocrats hoped the euro would create “cohesion” through a rise in per capita incomes in “peripheral” countries such as Ireland, Greece, Portugal, and Italy, bringing them closer to parity with “core” countries such as France and Germany. But instead of converging, the core and periphery grew further apart; Germany enjoyed an export boom, while on the periphery, foreign capital financed consumption, not investment.

Though it’s unclear whether these booms were caused by the euro, argues Barry Eichengreen, an economist at the University of California, Berkeley, there is no doubt that the EU needs to undertake serious reform to prevent future boom-and-bust cycles. He prescribes several measures, all of which would strengthen the hand of the EU relative to national governments.

First, the EU must strengthen the Stability and Growth Pact, through which it monitors the fiscal policies of member countries and ostensibly subjects offenders to sanctions and fines. Some steps have already been taken: In the past, sanctions could not be imposed absent a vote by the EU Council of Ministers. Now they proceed unless a vote overturns them.

Eichengreen’s second recommendation is meaningful stress tests for Europe’s banks. There are big obstacles to administering such tests: National governments are more interested in preventing their banks from losing market share than in making an honest assessment. Supervision of the stress tests will have to be delegated to a supranational authority. “If Europe has a single currency and a single financial market, it is going to need a single bank regulator,” Eichengreen says.

Finally, the EU should create a permanent emergency financing vehicle. “Crises will happen,” Eichengreen writes. “Not establishing a properly funded facility capable of providing emergency assistance is the macroeconomic equivalent of driving without a seat belt.”

These steps will not be easy politically, but if Europe’s leaders do not take the necessary precautions, “not just the euro but the EU itself could be at risk.”

* * *

The Source: "The Euro's Never-Ending-Crisis" by Barry Eichengreen, in Current History, March 2011. 

Photo courtesy of Flickr/mammal