UBS, the Swiss-based financial services company, recently published an analysis of the likely final outcome of the Eurozone crisis. They predicted “with an overwhelming probability” that the Euro would move towards some kind of fiscal integration. On the other hand, the chances of a break-up of the Euro is, according to UBS and economist Paul Donovan, “close to zero probability”. Slightly terrifying is their analysis of the risks of break-up:
It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.
Closer fiscal union could mean closer coordination of taxation and spending limits between European governments. It could mean a common “Eurobond” or even a single “European Finance Minister”. There are various suggestions on the table, some more radical than others. We recently spoke to Peter Spiegel, the Brussels bureau chief of the Financial Times, and presented some of the ideas from Debating Europe users for his reaction.
First up, what about the suggestion of massively expanding the European “bail-out” mechanism and allow it to buy up bonds in the secondary market?
I think that is a workable and likely solution to what’s going on right now. I think what all the financial markets are looking for is a lender of last resort. If you’re a holder of bonds, the ECB clearly does not want to be the lender of last resort – and in it’s charter it can’t be. If the European Finacial Stability Facility (EFSF) was expanded and allowed to be exactly that and jump into the secondary bond markets, I think that’s a very workable solution. It’s a positive idea.
What about the idea of launching a common Eurozone bond? Possibly used to finance some kind of “new Marshal plan” to grow Europe’s economy out of crisis? We had a suggestion along these lines from Paul. Here’s Peter Spiegel’s view:
I’ve yet to form my opinion. Of the people I’ve talked to who are advocating this, they argue that levels of debt in the eurozone are 88% to GDP, and that compares very favouarably to the US and Japan. If you pull it all together, you get a safehaven and a lot of liquidity. Look at the dollar: even though there’s been this horrible self-inflicted wound with the fight over raising the debt limit in the US, it’s still a safehaven. If you get a common Eurozone bond, I think it helps everyone. However, I’m not sure Germany would be willing to pay more. So I’m not sure it’s politically workable.
So increasing the “bail-out” fund is going to be more politically workable than introducing a common Eurobond?
The only thing holding back increasing the size of the EFSF is the worry about what that would mean for the debt rating of certain member-states. The guarantee from Germany and France, for example, gets counted against their national debt rating.
What do YOU think? Do you agree with Peter Spiegel that having a “lender of last resort” for the Eurozone is more workable than a common Eurobond? Do you have other ideas for fiscal union in Europe that you can suggest? Or perhaps you believe the opposite, that “less Europe” is the answer to the crisis? Let us know in the form below.
There are a number of issues that deserve a comment on this debate. I shall start from the “overwhelming probability” that the euro will move to some sort of a fiscal union.
First, the phrase “overwhelming probability” is nothing more than a personal belief, not something that derives from real world, facts, we shall see why later on, when I shall put down some thoughts on the concept of a fiscal union.
Second, the statement of Mr. Donovan is spot on, yet it is misleading for he does underline the qualitative difference between the euro and any other fiat currency. No other currency exists without a form of state to administer it, no other central bank is called to run a currency without a counterparty treasury with jurisdiction over the same currency area. Thus any comparison of that sort is at least inaccurate.
Third, expanding the EFSF will produce adverse effects for a number of issues. Firstly because the very structure of the mechanism is toxic since quasi-bankrupt states are called to bail out – and guarantee the loans to – their bankrupt partners. First it puts more pressure on the already hardly-pressed public finances of a number of states. For instance Italy and Spain who are facing the threat of losing market access (i.e. coming tot he need of a bailout themselves) are called to contribute to a second bailout to Greece. Second who would pay for that massive expansion of the funding capacity of the EFSF? The surplus countries of course. But if countries like France and Germany are called to contribute massive amounts of money to this degenerative fund, they the possibility of losing their triple-A credit rating increases, which means that the overall credibility of the mechanism decreases. In short, the EFSF as it is currently structured is leading with mathematical accuracy to a vicious cycle. The more it is expanded the greater the power of destruction.
Fourth, a eurobond in the way it is discussed, of mutualizing the system’s debt, will only produce the same sort of effects the EFSF produces (see point 3). A mutualization of debt, upon the assumption that it compares favorably to the US and Japan since overall debt is lower is false, since US and Japan are sovereign states, with full control of both monetary and fiscal policy and they can use all tools at their disposal to get away from their trouble. Whereas the Euro Area has many structural flaws that in fact prevent it from being as capable to act as the US and/or Japan.
And finally the fiscal union. It seems to me that we all make mention to a “fiscal union”, yet we are referring to something else, than what a fiscal union really is. The discussion on the matter centers around fiscal discipline and mechanisms/ ways of enforcing/achieving stricter fiscal rules. I am afraid to say that this is not a fiscal union, this is only a Stability and Growth Pact with an expanded scope of application. A real fiscal union implies fiscal transfers, a surplus recycling mechanism, a unified banking sector, a treasury. Take the treasury as an example… how much should Spain contribute to it, how much Greece, France, Germany etc. This is not an easy thing to decide and by the time it is, the euro will belong to history. Similar for all other issues relating to a fiscal union. The point is that it is not just about common fiscal rules – “discipline”. Of course we need common rules and of course we need a fiscal union in its proper sense, but this means that surplus countries will stop being as “surplus” as they are, for their surpluses will be transfered to deficit regions to achieve balanced growth and convergence.
There are many more things to say, however this is becoming too long, so I shall pause here.
12/09/2011 Daniel Dăianu, former Finance Minister of Romania, has responded to this comment.
I’ve just heard it suggested that the Greek crisis is actually helping the German economy. The reason goes as follows:
The financial world is increasingly unstable and at the moment the speculators are buying up currencies that look stable.
So Switzerland has been spending billions of francs to try and fix its value to 1.2 to the euro. As at the moment the Swiss economy is suffering as the value of its currency is going up. Exports and tourism have been badly hit and there is some evidence that even the rich ex-pats are beginning to consider moving as the foreign exchange rates are cutting into their income earned outside the country.
If Germany still had the Dmark then being a much larger country than Switzerland and having a strong economy the speculators would be investing heavily in the mark, increasing its comparative value, which in turn would make German exports expensive, with the consequence that German industry would be very badly hit.
Being part of the eurozone, which is having a continuous series of financial crises means that the euro’s exchange value is a lot lower than it should be. This also means that Germany products cost less in the world markets and this is one of the main reasons why Germany is doing so well despite the international problems.
So in a way the problems of Greece, Ireland and Portugal are helping Germany to maintain its industry, its relatively high employment and its exports.
It is therefore in Germany’s long term interest to work with the weaker economies and to have the value of its currency adversely affected by their problems.
It therefore suggests a stronger, eurozone monetary union is needed and I would suggest if the zone is backed by eurobonds it would not only help the weaker countries build their economies over time, but also, by keeping the value of the euro reasonably low help maintain the exports of the more developed economies, such as Germany, France and Finland.
Now who is going to break this news to Chancellor Merkel and how are we going to sell it to the German voters?
The Germans already know that they are better off in a currency union. The problem is that some countries have abused the privilege of having access to cheap credit, and borrowed beyond their means. Now they want to pool the debt by asking for the ECB to act as a “lender of last resort.” The Germans should remain firm on this, and insist on a future “debt brake” mechanism instead, with only some limited amount of debt forgiveness. As I live in Ireland, I can see it is impossible for us to pay off the amount of money we owe, unless interest rates are reduced to almost nothing and the term of the loan extended indefinitely. It was foolish for us to borrow so much, and equally foolish for Frankfurt to invest in/lend it to our failed banks. Our economy is now in a downward spiral which will get worse in the next few years under the ever increasing austerity measures. As poverty increases, and labour costs fall, our economy will gradually recover, but it is a hard lesson to learn. The debt brake, credit limits, and shared inputs into national budgetary decisions should have been built into the Euro from the beginning.
Since 1950 European nations have incrementally integrated their economies through free-trade agreements, fixed currency exchange rates, and ultimately a single currency and a single monetary authority—the European Central Bank—that decides interest rates for the Eurozone. This monetary integration has reduced transaction costs and enabled the free movement of labor, goods, services, and capital. But there have been negative consequences as well.
My recent research with Massimo Morelli from Columbia University and Jośe Taveres from Nova School of Business and Economics finds that the current monetary integration does not provide the adequate means to address expected income shocks, which could lead nations to leave the Eurozone. This is because when member nations joined the Eurozone in 1999, their officials lost a primary fiscal tool to ameliorate the effects of volatility—the ability to adjust interest rates.
The problem of a single interest rate was clear in between 2002 and 2005 when Spain experienced high growth while Germany had low growth. Germany’s influence in the European Central Bank played a crucial role to bring about low interest rates at a time when Spain would have benefited from higher interest rates that could have helped avoid a bubble. The result was a collapse in Spain’s real estate sector.
Given the heterogeneity among the Eurozone nations, a single interest rate may not be optimal for all member nations, particularly when the volatility of income shocks is high. We argue that this difference in volatility among Euro countries may have altered their regime preferences. Countries prefer to form a monetary union, without fiscal policy integration, if volatility is low for all (or some) countries. When volatility jumps for some countries, support for a fiscal union increases because a fiscal union enables transfers across countries to compensate for the lack of independent monetary policy. Without a fiscal union, high-volatility countries, such as Greece, would be better off leaving the Euro.
In separate research Abderrahim Taamouti of Durham School of Business and I argue that the Euro itself has been a cause of low economic growth and high volatility in Greece, Ireland, Portugal, and Spain long before the financial crisis. Adoption of the Euro itself made the realization of volatilities even more extreme.
The main question is how to make the creation of a fiscal union possible. It may be necessary to offer economic and political incentives to countries with low volatility to gain their support for the fiscal union. Moving toward fiscal integration would require allocating more bargaining power to countries that are paying more to fund transfers to nations in recession.
Thomas Picketty has advocated for a wealth tax to fund these transfers. I don’t think that such a tax would be effective because assets can be moved to other jurisdictions to avoid it. Instead, I think the most effective way to ameliorate economic and fiscal imbalances is through a tax on speculative real estate transactions because investors like safe havens such as real estate and because real estate is tangible and stationary. Such a tax would reduce excessive speculation in markets with skyrocketing prices and inject money into economically struggling nations to reduce the possibility of defaults.
The creation of a fiscal union seems less plausible than ever. Greece is close to abandoning the Euro, and political opposition to the Euro is growing in many Eurozone member countries. Currently, taxes are the only tool available to address negative shocks, but those taxes aren’t enough. Transfers are necessary to maintain the union because if one nation were to leave the EU, others, particularly those in recession, would likely follow suit.
Wisconsin School of Business
University of Wisconsin – Madison Wisconsin School of Business
For more, see the following:
“A Volatility-based Theory of Fiscal Union Desirability”
“Did the Euro Change the Effect of Fundamentals on Growth and Uncertainty?”
First of all We all must decide what We want from the EU.
Do the EU citizens simply want an European Common Market?
If Yes, then We’ve no need for any form of centralized european government. The national ones would be enough!
Do the EU citizens want a Federal European Union (Federal or Confederal should be discussed)?
If Yes then it’s high time to decide which should be the competences and decision making powers that a central european government should have and which should be kept by the national governments.
In this way it makes all the sense to have centralized “institutions” like Fiscal Union or a Common Currency for example!
If the EU citizens are divided between both answers, then why not applying both answers!
There’s already two examples of this in use. Both the Eurozone and the Schengen Area which encompass situations where there are EU member states that belong to none, one or both agreements and even NON EU states that belong to one or both agreements (in special status or agreements).
What would impede that a core group of EU member states could advance to a Federal State, as presented, while another core could stay well within the boundaries of what the EEC was at the time with or without the capacity to belong to the Eurozone, Schengen Area or other agreements?
For me nothing besides the point that, depending on the level of commitment with the European Project so the European funds, investments, developments and so on should/would be implemented/prefered!
Thanks for Your time and I hope that You enjoy, in a critical manner, my opinion.