Tilford and Whyte on the euro crisis

Simon Tilford and Philip Whyte have written an essay – Why stricter rules threaten the eurozone” – on the euro crisis for the normally strongly pro-European Centre for European Reform. I far from agree with everything in the report, but it is worth a read.

Here is the conclusion (for the lazy):

“When the euro was launched, critics worried that it was inherently unstable because it was institutionally incomplete. A monetary union, they argued, could not work outside a fiscal (and hence a political) union. Proponents of the euro, by contrast, believed that a currency union could survive without a fiscal union provided it was held together by rules to which its member-states adhered. If, however, a rules-based system proved insufficient to keep the monetary union together, many supporters assumed (as faithful disciples of Jean Monnet) that the resulting crisis would compel politicians to take steps towards greater fiscal union.

Initially, proponents of the euro seemed to have been vindicated. The euro enjoyed a remarkably uneventful birth, and a superficially blissful childhood. But its adolescence has been more troubled, lending increasing weight to the euro’s critics. If anything, a shared currency outside a fiscal union has turned out to be even less stable than the critics imagined. Common fiscal rules did not guarantee the stability of the system – not just (as North European politicians like to claim) because they were broken, but also because they were inadequate. The eurozone now faces an existential crisis – and EU politicians their ‘Monnet moment’. At root, the eurozone’s sovereign debt crisis is a crisis of politics and democracy. It is clear that the eurozone will remain an unstable, crisis-prone arrangement unless critical steps are taken to place it on a more sustainable institutional footing. But it is equally clear that European politicians have no democratic mandate in the short term to take the steps required. The reason is that greater fiscal integration would turn the eurozone into the very thing that politicians said it would never be: a ‘transfer union’, with joint debt issuance and greater control from the centre over tax and spending policy in the member-states.

Eurozone leaders now face a choice between two unpalatable alternatives. Either they accept that the eurozone is institutionally flawed and do what is necessary to turn it into a more stable arrangement. This will require some of them to go beyond what their voters seem prepared to allow, and to accept that a certain amount of ‘rule-breaking’ is necessary in the short term if the eurozone is to survive intact. Or they can stick to the fiction that confidence can be restored by the adoption (and enforcement) of tougher rules. This option will condemn the eurozone to selfdefeating policies that hasten defaults, contagion and eventual break-up. If the eurozone is to avoid the second of these scenarios, a certain number of things need to happen. In the short term, the ECB must insulate Italy and Spain from contagion by announcing that it will intervene to buy as much of their debt as necessary. In the longer term, however, the future of the euro hinges on the participating economies agreeing at least four things: mutualising the issuance of their debt; adopting a pan-European bank deposit insurance scheme; pursuing macroeconomic policies that encourage growth, rather than stifle it (including symmetric action to narrow trade imbalances); and lowering residual barriers to factor mobility.”