The European Union released its estimates for first quarter
growth this week. the results were, in a word, “dreadful.” The chart below from
the Financial
Times, here,
sums up the situation. Even the most ardent supporter of the European project
no doubt finds it difficult to put a positive spin on the numbers. Sadly, the
prognosis is more of the same.
Almost
a year ago, G20 leaders met at Los Cabos, Mexico amid
widespread concern (crisis-induced panic?)
regarding the prospects of a possible Greek exit from the euro zone. Under the
watchful eye of their G20 colleagues, Europe’s leaders agreed to “support the
intention to consider concrete steps towards a more integrated financial
architecture, encompassing banking supervision, resolution and
recapitalization, and deposit insurance.” In other words, to work toward
measures to stem the crisis that was threatening the financial systems of euro
zone members and posed a clear and present danger to the global economy, writ
large. First and foremost was agreement on the need to build an effective
banking union.
The show of unity that euro zone leaders displayed in Los Cabos conveyed
the impression that they understood the gravity of the situation and
were prepared, possibly, to grasp the nettle and fill the governance
gaps in their joint project; yet, what restored calm to European
financial markets was not the pronouncements of leaders at Los Cabos,
but the determination of Mario Draghi (President of the European Central
Bank) to “do whatever it takes” to preserve the euro. His commitment to
provide liquidity to markets halted last summer’s panicked bank-run
flight from euro-denominated assets and euro zone banking systems into
relative calm.
This episode nicely
illustrates the unique power of how the judicious use of monetary
policy can affect expectations and thereby shift the economy from one
outcome to another. It is, in other words, a social coordination
mechanism that supports “good” equilibria and avoids “bad” outcomes.
But, make no mistake, Draghi did not, and monetary policy measures alone
could not, address the fundamental governance failures in the euro
zone.
In this respect,
the euro land members face two options if they want to continue with the
project of European monetary union. The first option is to continue
down the road of “internal devaluation” and structural reforms that
will, eventually, restore full employment as real wages in the periphery
adjust downward to compensate for reduced levels of productivity. That
is the well-trodden path of the past several years; it entails continued
high unemployment — at Great Depression levels in some countries — and
strains the social and political fabric of countries making the
adjustment.
The second option
is to create the institutions needed to support a monetary union for
countries that do not satisfy the conditions of an optimal currency
area. This will take considerable time. It is the road less travelled.
And, frankly, it is the more difficult path because it requires
political institution building and the delegation of national
sovereignty.
This is the crux of
the matter: a decade ago, member states might have been prepared to
cede national sovereignty to euro land institutions in order to reap the
benefits that monetary union would bring. (No state voluntarily gives
up sovereignty, but “pooling” sovereignty with others might be
attractive if the prospective gains are big enough.) The decision rule
is simple: “stay” if the discounted present value of benefits from
remaining in the euro zone exceed the discounted present value of the
costs; otherwise “exit.”
The rule is simple,
but the considerations involved are vastly more complex. This no doubt
accounts for the hesitation and false steps that euro members have shown
with respect to building euro area institutions. This week German
Finance Minister Wolfgang Schäuble cast doubt on the legality of plans
for an EU-wide bank resolution and rescue agency. In doing so, he is
defending the interests of German taxpayers, who would likely bear the
brunt of the costs of future bank failures.
For the immediate
future, therefore, the road not taken will likely remain the road not
taken. In the meantime, markets may test Mario Draghi’s commitment,
which, it could be argued, was given in exchange for institutional
reforms; Europe will likely remain weight on the global economy in the
New Age of Uncertainty.
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