Solutions to the euro crisis

In: Blog

2 Oct 2011

By: Andrea Terzi

Well, like all economists always do, let’s assume!

Let’s assume that Europeans have two goals:

1) Preventing sovereign debt defaults to avert a full-blown banking crisis; and

2) Saving the political project of the single currency that Europeans regard as a fundamental pillar of the integration process that started right after World War II.

Question: Should Europeans work towards reaching goal #2 in order to secure goal #1, or can they achieve goal #1 and then work towards goal #2?

If the euro area were already a political entity (like the United States) with a federal treasury and a central bank that acts as a market maker of treasury securities consistent with its policy rate, none of the sovereign debt problems would have occurred. Objecting that even the U.S. is not immune from a sovereign debt crisis is highly misleading: The U.S. “debt ceiling” crisis last summer was caused by a potential Congressional vote to deliberately suspend payments to private creditors of the U.S. government. By contrast, euro countries currently under pressure are very much willing to honor all their payments as they come due, but they are constrained by their status of regional entities (much like single states in the U.S.) and thus must face external funding constraints. In principle, Europeans could achieve goal #1 by first completing goal #2: Once Europeans have taken the full federation step, the sovereign debt crisis evaporates.

Because the euro area is not a political federation and is instead a union of countries that share the same currency but do not share the same treasury, the above question becomes crucial. Is a European federation, or at least some significant transfer of sovereignty from single states to a centralized EU body, a condition for achieving goal #1?

Let’s further assume that time for preventing a full-blown crisis is running out and that any sovereign transfer decisions must overcome political resistance in Europe and would take time. In that case, achieving goal #1 depends crucially on the possibility of doing it before Europe makes any progress towards goal #2. And it should be in the interest of Europeans to search and find solutions to #1 that do not require addressing #2 first.

Examples of proposals being discussed that include some form of political sovereignty transfer include those by Tabellini and Soros.

The only effective proposal around so far, to my knowledge, that directly aims at goal #1 (and does not require political reforms) is some combination of the ECB revenue-sharing solution and the ECB acquisition of Mosler bonds. This is not an easy political sell either, yet implementation of it before Europe finds itself on the brink of collapse would be a European boon!

3 Responses to Solutions to the euro crisis

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Sigurd Persson

December 20th, 2011 at 10:50

Solution done simple:
I will suggest that countries in trouble should use dobbel currencies. That will say that Italy starts using Lire internaly. Customers in that country can choose to use either Lire or Euros. All government payouts and loans will be converted to Lire.

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El Tata

June 16th, 2012 at 22:25

Ohhh. We lived all of that. In march 1975, after communist government was ousted, we had a 400% inflation going to 1000% by the end of the year. Then, the answer was shock: 30% less fiscal spending, 15% decrease product, 20% unemployment. The situation was checked and economy recovery in one year. In 1982 the problem was different: 0% fiscal deficit, very high private debt, fixed rate of exchange (but with internal inflation running high). Then “we pass to the drachma” (lo cal currency fell against dollar). Unemployment reached 30%, product fell 14%. After that the country started growing at 10% per year and now is Nº 1 in Latin America. In the mean time, the State took charge for negotiation of all debts, took control of banks and companies (all later privatized), reformed the labor market and pension funds. Our sovereign rate is better than that of many countries of south Europa. ohhhh, yes, we had a man with gusts. The man is under the carpet now and will be there for many years. But around 2030 we will put its statue in Santiago main square, because he has been the best Chilean president since 1541.

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Lou

June 18th, 2012 at 16:06

Europeans have neither goal….assume away…

Actually many Europeans on the ground would like to default as Iceland did and would like a break-up of the Euro.

Or debt write off and restructuring.

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