A super column by the Euro historian Barry Eichengreen.
The current Eurozone proposals of banking union, fiscal union and political union are based on two diametric opposite approaches. The first is a fix it approach with institutions coming later. Second is build institutions now so that these short term fixes do not arise:
Vision aplenty. The problem is that there are two diametrically opposed approaches to implementing it. One strategy assumes that Europe desperately needs the policies of this deeper union now. It cannot wait to inject capital into the banks. It must take immediate steps toward debt mutualization. It needs either the ECB or an expanded European Stability Mechanism to purchase distressed governments’ bonds today.
Over time, according to this view, Europe could build the institutions needed to complement these policies. It could create a single bank supervisor, enhance the European Commission’s powers, or create a European Treasury. Likewise, it could strengthen the European Parliament. But building institutions takes time, which is in dangerously short supply, given the risk of bank runs, sovereign-debt crises, and the collapse of the single currency. That is why the new policies must come first.
The other view is that to proceed with the new policies before the new institutions are in place would be reckless. Mutualizing debts before European institutions have a veto over fiscal policies would only encourage more reckless behavior by national governments. Proceeding with capital injections before the single supervisor is in place would only encourage more risk taking. And allowing the ECB to supervise the banks before the European Parliament acquires the power to hold it accountable would only deepen the EU’s democratic deficit and provoke a backlash.
Interestingly, Europe has been here before. Euro was created taking the first view:
Europe has been here before – in the 1990’s, when the decision was taken to establish the euro. At that time, there were two schools of thought. One camp argued that it would be reckless to create a monetary union before economic policies had converged and institutional reforms were complete.
The other school, by contrast, worried that the existing monetary system was rigid, brittle, and prone to crisis. Europe could not wait to complete the institution-building process. It was better to create the euro sooner rather than later, with the relevant reforms and institutions to follow. At the slight risk of overgeneralization, one can say that the first camp was made up mainly of northern Europeans, while the second was dominated by the south.
The 1992 exchange-rate crisis then tipped the balance. Once Europe’s exchange-rate system blew up, the southerners’ argument that Europe could not afford to postpone creating the euro carried the day. The consequences have not been happy. Monetary union without banking, fiscal, and political union has been a disaster.
Prof. Eich argues that without Euro things would have been worse:
But not proceeding would also have been a disaster. The 1992 crisis proved that the existing system was unstable. Not moving forward to the euro would have set up Europe for even more disruptive crises. That is why European leaders took the ambitious steps that they did.
Not proceeding now with bank recapitalization and government bond purchases would similarly lead to disaster. Europe thus finds itself in a familiar bind. The only way out is to accelerate the institution-building process significantly. Doing so will not be easy. But disaster does not wait.
I am surprised to read this. There are two issues:
- One usually sees econs arguing that the experiment was wrong to begin with. Prof. says it would have been worse if the project was not launched.
- After the hurried approach for euro resulting into the current crisis, the lesson perhaps could be to go slow on next round of such measures.
However, as Prof points, going slow might be more disastrous. Such is the case of Europe…
