16 February 2016

VoxEU: How to reboot the eurozone and ensure its long-term survival

The eurozone in its current state is not an optimal currency area and is fragile. Since a stabilisation fund and a budgetary union are politically unobtainable right now, small steps should be implemented to create some fiscal space, and to start with a limited programme of debt consolidation.

Conclusion

We have identified the conditions under which the eurozone’s fragility can be eliminated making it possible for the monetary union to survive. But these conditions are politically very intrusive, requiring a very large transfer of sovereignty from nation states to a central Eurozone authority. The conclusion can only be that this is politically impossible today.

History teaches us that what one considers politically impossible at one moment of time can quickly change and become possible when conditions become extreme. Nevertheless, today a political union such as the one we have spelled out appears for most of us to be out of reach.

There are two possible reactions to this situation. One is to despair and to conclude that it would be better to dissolve the monetary union. It will never work anyway. The other reaction is to say, yes it will be very difficult, and the chances of success are slim, but let’s try anyway. That is the position we are taking.

If one takes this attitude one quickly comes to the conclusion that success can only occur by following a strategy of small steps. A revolutionary approach will simply not work.

What are these small steps?

We see essentially two.

• One is to create some fiscal space at the level of the eurozone.

An example is a common unemployment insurance scheme that would insure the cyclical component of unemployment (so as to minimise moral hazard problems). This insurance scheme should have a large component of insurance over time. We have made a proposal for a business cycle stabilisation effort that could complement such an insurance scheme.

• Another small step is to start with a limited programme of debt consolidation.

That must take care of moral hazard issues that naturally arise with such schemes. The best way to achieve this is by introducing an element of co-insurance. This can be done by limiting the common issue of government bonds to a given percent of GDP, e.g. 60%. What exceeds this limit must be issued by the individual government (see Delpla and von Weizsäcker 2010).

These are small steps. Even these small steps, however, encounter severe hostility and will be difficult to take. Yet these steps will have to be taken if we want to avoid the future disintegration of the Eurozone.

Our task as economists is to make this choice clear to the rest of the population; we should tell them that if they want to keep the euro, steps towards more political union are inevitable. If they do not want to take these steps, they will have to say goodbye to the euro.

Full article on VoxEU

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