Opinion

The Lesser Evil for the Eurozone

For three decades, the consensus within the European Commission and the European Central Bank on the need for market reforms and sound public finances has been strong enough to overcome opposition in small countries and outlast procrastination in large ones. Today, however, the Eurozone playing field has become a battleground.

By: Date: April 4, 2018 Topic: Finance & Financial Regulation

This opinion piece has been published in Project Syndicate

It was not supposed to happen like this. The formation of a new German government took so long that it was only after the Italian general election on March 4 resulted in a political earthquake that France and Germany started to work on reforming the eurozone. German Chancellor Angela Merkel and French President Emmanuel Macron have now resolved to sort out their differences and deliver a joint reform roadmap by July. But they cannot ignore changes brought by the landslide victory of Italy’s anti-system parties. Until then, populism had seemed contained. It has now become mainstream.

For those who will have to draw the Franco-German blueprint, the message from Italy is that the policy framework that has dominated Europe since the mid-1980s no longer commands broad support. For three decades, the consensus on the need for market reforms and sound public finances has been strong enough to overcome opposition in small countries (Greece) and outlast procrastination in large ones (France). In the coming years, however, the eurozone playing field may well become a battleground.

The first casualty is bound to be the European Stability and Growth Pact, with its plethora of fiscal rules, monitoring procedures, and eventual sanctions for excessive deficits. The 224-page Vade Mecum on implementing fiscal discipline in the EU is hopelessly complex, to such a degree that no finance minister, let alone parliamentarian, fully understands what his or her country must abide by.

For populists, however, indecipherable rules made in Brussels are a simple, straightforward political target. In “Baron Noir” (Black Baron), a popular French TV series, a president engulfed in a financial scandal nearly escapes public indignity by mounting a coalition against EU deficit fines. With populism rising almost everywhere in Europe, reality may soon exceed fiction. For large countries, the threat of sanctions has always been a paper tiger. The difference now is that the EU’s bluff may be called.

Absent sanctions, what will ensure that participants in the eurozone behave? This is what Germany is understandably worried about. Whatever reservations one may have about Germany’s fiscal obsession, rules of the game are required to deal with unsustainable public-debt accumulation in a monetary union. Policy ambiguity cannot be relied on, in a system deprived of a strong power center. If no one knows what will happen if a country does not behave, the expectation may turn out to be that debts will be monetized – at a high inflationary cost.

At a recent conference in Berlin, economists debated what to do if the euro proves unsustainable. Prominent German scholars expressed the view that, absent credible sanctions, only the threat of forced exit could discipline wayward eurozone members. In other words, governments should be facing a clear choice: behave or leave.

Technically, this would not be hard to implement. To force out a delinquent country, the ECB could simply unplug its banking system from euro liquidity. That nearly happened in 2015, when Greece was on the brink of exit, and Wolfgang Schäuble, Germany’s finance minister at the time, considered pushing Greece out. It took a long, dramatic night of talks for eurozone leaders to agree not to do it.

Pushing a country out would, however, have dire consequences. The irreversibility of the euro may be a myth – nothing is irreversible – but it is a useful myth. If businesses and savers were to start speculating about the next exit, trust in the common currency would soon vanish. People would move their savings to protect them from redenomination risk. A German euro would be worth more than a French euro, which in turn would be worth more than an Italian euro. That’s why Mario Draghi, the ECB’s president, said in 2012 that he would do “whatever it takes” to preserve the euro’s integrity.

So, what if sanctions don’t work and the threat of exit is a cluster bomb that would hurt everyone? In a recent paper with French and German colleagues, we advocate making debt restructuring within the eurozone a credible possibility. We do not regard debt restructuring as benign, let alone desirable, and we do not advocate making it automatic or driven by numerical triggers.

But, in a system without sanctions, fiscal responsibility can be enforced only if two conditions are met. First, governments and those who finance them must face the consequences of irresponsibility – that is, ultimately, debt restructuring. Second, the ensuing financial disruption must be limited, so that policymakers do not want to avoid restructuring at all costs. This, in turn, requires a number of reforms that we spell out in our paper.

This idea elicits strong reservations, not only in Italy, where the policy establishment is obsessed with the country’s record indebtedness, but also in France, where debt repayment is regarded as the dividing line between advanced and developing countries. The memories of the Deauville summit – an ill-conceived regime for addressing excessive public debt hashed out by Merkel and then-French President Nicolas Sarkozy – are still vivid. The French view is that debt restructuring should not be contemplated, even as a possible outcome.

But the French must confront the new reality. While the euro survived the financial disruption of 2010-2012, it is now confronted by a potentially more challenging political disruption. This threat must be faced.

Absent a shared consensus on the sanctity of rules, there are not many possibilities. One is a euro without an anchor, something Northern Europe would not want to remain part of for long. Another is a euro with a wide-open exit door, something that would quickly lead to another financial crisis. And still another is a euro with defined and predictable internal debt-resolution mechanisms. The latter option is, admittedly, not without risks, but it is certainly safer than the exit threat. France, and Europe, should choose the lesser evil.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read about event More on this topic

Upcoming Event

Jun
25
08:30

How comprehensive is the EU political realignment?

Has the left-right divide become obsolete in EU politics?

Speakers: David Amiel, Otilia Dhand, Nicolas Véron and Silke Wettach Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic

Policy Brief

A strategic agenda for the new EU leadership

Memo to the presidents of the European Commission, Council and Parliament. 'A strategic agenda for the new EU leadership' by Maria Demertzis, André Sapir and Guntram Wolff is the first of our 2019 Bruegel memos to the new presidents of the European Commission, Council and Parliament. Focusing on the most important economic questions at EU level, these Bruegel memos are intended to be a strategic to-do list, outlining the state of affairs that will greet the new Commission.

By: Maria Demertzis, André Sapir and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 13, 2019
Read about event More on this topic

Past Event

Past Event

Past, present, and future EU trade policy: a conversation with Commissioner Malmström

What was trade policy during the last European Commission? What will be the future of European trade under the next Commission?

Speakers: Cecilia Malmström, André Sapir and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 13, 2019
Read article Download PDF More on this topic

External Publication

Effectiveness of cohesion policy: learning from the project characteristics that produce the best results

This study by Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza, and Catarina Midões analyses the characteristics of cohesion policy projects that can contribute to successful outcomes. Their analysis is based on a literature survey, an econometric analysis and interviews with stakeholders. About two dozen project characteristics are considered, and their association with economic growth is studied using a novel methodology. Based on the findings, the study concludes with recommendations for cohesion policy reform.

By: Zsolt Darvas, Antoine Mathieu Collin, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: June 11, 2019
Read article More on this topic More by this author

Opinion

L’euro sans l’Europe : un projet incohérent

Jean Pisani-Ferry constate que tous les grands partis ne remettent plus en cause l’euro. Il souligne néanmoins que trois vulnérabilités – économique, politique et internationale – menacent la monnaie unique.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: May 28, 2019
Read article More on this topic More by this author

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 27, 2019
Read article Download PDF More on this topic

Policy Contribution

How to improve European Union cohesion policy for the next decade

This policy contribution investigates the performance of the design, implementation and effectiveness of cohesion policy, the most evaluated EU tool for promoting economic convergence. By analysing the effects of cohesion policy on economic growth through reviewing literature, conducting empirical research by comparing regions, as well as considering attitudes and expectations collected through interviewing stakeholders, the authors provide reform recommendations.

By: Zsolt Darvas, Jan Mazza and Catarina Midoes Topic: European Macroeconomics & Governance Date: May 23, 2019
Read about event More on this topic

Past Event

Past Event

Europe after Sibiu: Towards differentiated integration?

A comprehensive follow-up to the Informal European Council in Sibiu, Romania.

Speakers: Andrew Duff, John Erik Fossum, Paweł Karbownik and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 21, 2019
Read article More on this topic More by this author

Blog Post

European bank resolution plans are undermined by a lack of transparency

The discussions of the now-aborted merger of Germany’s two largest banks underlined supervisors’ concerns over creating banks that are too big or too complex to fail. While European banks are increasingly funded through securities that could be subject to a bail-in, transparency over how any resolutions would unfold is as yet very poor.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: May 15, 2019
Read article More on this topic More by this author

Blog Post

Developing resilient bail-in capital

Europe’s largest banks have made progress in issuing bail-inable securities that shelter taxpayers from bank failures. But the now-finalised revision of the bank resolution directive and a new policy of the SRB will make requirements to issue such securities more onerous for other banks. In order to strengthen banking-system resilience, EU capital-market regulation should facilitate exposures of long-term institutional investors.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: April 29, 2019
Read article Download PDF More by this author

External Publication

European Parliament

Taking stock of the Single Resolution Board: Banking union scrutiny

The Single Resolution Board (SRB) has had a somewhat difficult start but has been able to learn and adapt, and has gained stature following its first bank resolution decisions in 2017-18. It must continue to build up its capabilities, even as the European Union’s banking union and its policy regime for unviable banks continue to develop.

By: Nicolas Véron Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: April 18, 2019
Read about event More on this topic

Past Event

Past Event

Spitzenkandidaten series: Frans Timmermans

The sixth event in the The Road to Europe - Brussels Briefing Live: Spitzenkandidaten series. The series features the lead candidates for the European Elections of six parties and is jointly organised by Bruegel and the Financial Times in March and April 2019.

Speakers: Mehreen Khan, André Sapir and Frans Timmermans Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 11, 2019
Load more posts