Moving On From The Euro
Kevin O’Rourke
European
Monetary Union was never a good idea. I remember my surprise when, as a
young assistant professor, I realized that I was opposed to the
Maastricht Treaty. I believed then – and still do – that European
integration is a very good thing. But the textbook economics I was
teaching showed how damaging EMU could be in the absence of European
fiscal and political union.
Nothing
that has happened since has convinced me that the textbook was
excessively pessimistic. On the contrary: it was far too optimistic.
Life is strewn with banana skins, and when you step on one you need to
be able to adjust. But the monetary union itself turned out to be a
gigantic banana skin, inducing capital flows that pushed up costs around
the European periphery. And adjustment – that is, currency devaluation –
was not an option.
Furthermore,
most textbooks of the time ignored the financial sector; thus, they
ignored the fact that capital flows to the periphery would be channeled
via banks, and that when the capital stopped flowing, bank crises would
strain peripheral members’ public finances. This, in turn, would further
erode banks’ balance sheets and constrain credit creation – the
sovereign-bank doom loop that we have heard so much about in recent
years. And no textbooks predicted that European cooperation would impose
pro-cyclical austerity on crisis-struck countries, creating depressions
that in some cases have rivaled those of the 1930s.
It
has been obvious for some years that the “actually existing EMU” has
been a costly failure, both economically and politically. Trust in
European institutions has collapsed, and political parties skeptical not
just of the euro, but of the entire European project, are on the rise.
And yet most economists, even those who were never keen on EMU in the
first place, have been reluctant to make the argument that the time has
come to abandon a failed experiment.
A famous article by Barry Eichengreen pointed
out that an anticipated EMU breakup would lead to the “mother of all
financial crises.” It is hard to disagree with him. That is why
economists of all stripes, whether or not they supported the
introduction of the common currency, have spent the last five years
developing and promoting a package of institutional reforms and policy
changes that would make the eurozone less dysfunctional.
In
the short run, the eurozone needs much looser monetary and fiscal
policy. It also needs a higher inflation target (to reduce the need for
nominal wage and price reductions); debt relief, where appropriate; a
proper banking union with an adequate, centralized fiscal backstop; and a
“safe” eurozone asset that national banks could hold, thereby breaking
the sovereign-bank doom loop.
Unfortunately,
economists have not argued strongly for a proper fiscal union. Even
those who consider it economically necessary censor themselves, because
they believe it to be politically impossible. The problem is that
silence has narrowed the frontier of political possibility even further,
so that more modest proposals have fallen by the wayside as well.
Five
years on, the eurozone still lacks a proper banking union, or even, as
Greece demonstrated, a proper lender of last resort. Moreover, a higher
inflation target remains unthinkable, and the German government argues
that defaults on sovereign debt are illegal within the eurozone.
Pro-cyclical fiscal adjustment is still the order of the day.
The
European Central Bank’s belated embrace of quantitative easing was a
welcome step forward, but policymakers’ enormously destructive decision
to shut down a member state’s banking system – for what appears to be
political reasons – is a far larger step backward. And no one is talking
about real fiscal and political union, even though no one can imagine
European Monetary Union surviving under the status quo.
Meanwhile,
the political damage is ongoing: not all protest parties are as
pro-European as Greece’s ruling Syriza. And domestic politics is being
distorted by the inability of centrist politicians to address voters’
concerns about the eurozone’s economic policies and its democratic
deficit. To do so, it is feared, would give implicit support to the
skeptics, which is taboo.
Thus,
in France, Socialist President François Hollande channels Jean-Baptiste
Say, arguing that supply creates its own demand, while the far-right
National Front’s Marine Le Pen gets to quote Paul Krugman and Joseph
Stiglitz approvingly. No wonder that working-class voters are turning to
her party.
A
victory for the National Front in 2017 or 2022, which is no longer
unthinkable, would destroy the European project. Citizens of smaller
eurozone member states will have noted the brutal way the ECB was
politicized to achieve Germany’s goals in Greece, and the conclusion
that the eurozone is a dangerous “union” for small countries will seem
inescapable. If centrist parties remain on the sidelines, rather than
protesting what has happened, the political extremists will gain further
valuable territory.
As
for economists like me, who have balked at advocating an end to the
failed euro experiment and favored reform, perhaps it is time to admit
defeat and move on. If only anti-Europeans oppose EMU, the EU baby could
end up being thrown out with the euro bathwater.
An
end to the euro would indeed provoke an immense crisis. But ask
yourself this: Do you really think the euro will be around in its
present form a century from now? If not it will end, and the timing of
that end will never be “right.” Better, then, to get on with it before
more damage is done.
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