26 January 2012

Bergsten/Kirkegaard: The coming resolution of the European crisis

What we are seeing is a game of chicken among the key political and economic powers in Europe. As the crash looms ever closer, the right deals will be struck and Europe will emerge stronger and with its currency intact.

"When things get really difficult ... suddenly solutions which seemed impossible become possible….Because of this, the crisis represents an opportunity. I'm not saying that I enjoy being in a crisis, but I'm not worried. Europe always moved forward in times of crisis. Sometimes you need a little pressure for certain decisions to be taken."—Wolfgang Schäuble

"Europe will be forged in crises, and will be the sum of the solutions adopted for those crises."—Jean Monnet

Doom and gloom about the euro are abundant. An increasing number of commentators and economists have started to question whether the common currency can survive. The economic and financial problems in the eurozone are clearly serious and plentiful. The area is in the midst of multiple, frequently overlapping and mutually reinforcing crises.

• A fiscal crisis is centred in Greece but visible across the southern eurozone and Ireland.
• A competitiveness crisis is manifest in large and persistent pre-crisis current-account deficits in the eurozone periphery and even larger intra-eurozone current-account imbalances.
• A banking crisis was first evident in Ireland but is now spreading throughout the eurozone via accelerating concerns over sovereign solvencies.

The authors, Fred Bergsten and Jacob Funk Kirkegaard, however, think that these fears are overblown. They believe that the European crisis is political, and even largely presentational. This realisation holds the key to understanding how it has developed and to its solution.

There are today only two alternatives in front of European leaders:

• Europe could jettison the monetary union, and in the process reverse 60 years of gradual political and economic integration; or
• it could adopt a complementary economic union.

Bergsten/Kirkegaard believe that, for all the turmoil, Europe is well on its way to completing the original concept of an economic and monetary union. Indeed, they are convinced that Europe will emerge from the crisis much stronger as a result.

Stabilisation and resolution on the way: What next?

Bergsten/Kirkegaard... believe the eurozone crisis – despite the superficial appearance of the opposite – is well on the way towards stabilisation and resolution. The final major political challenge on the eurozone agenda for 2012 goes beyond measures to address the immediate crisis and will instead focus on the longer-term continuation and direction of eurozone institutional reform.

During 2012, the eurozone is likely to adopt a new and considerably more credible set of fiscal rules and budget-oversight regulation. This has been a clear demand from both the ECB and Germany. But while the new fiscal compact will undoubtedly help stabilise the eurozone in the future, it must be thought of as merely a beginning of the institutional reforms needed in the region.

Fiscal consolidation is not everything and the movement towards further and symmetrical deepening of eurozone fiscal integration must be maintained. Following the ‘fiscal rules first’ down payment, eurozone leaders must consequently take further concrete steps in 2012 on a reasonable timetable towards the introduction of eurobonds or the expansion of the ESM firewall (+ potential IMF involvement) to magnitudes which will help assuage financial markets and facilitate an expeditious reduction in the interest rates of especially Spain and Italy.

Conclusions

It has taken ten years since the introduction of the euro for the first serious economic and political crisis to arrive. The most challenging part of today’s crisis is to use the political opportunity it presents to get the basic economic institutions right and complete the euro’s half-built house for the long-term. In this process the euro will develop in a different manner from the full economic and monetary union established in the US. It will require further substantial Treaty and institutional revisions in the future.

As the US Constitution’s 27 current amendments clearly show, faulty initial designs need not preclude long-term success. If the history of the integration exercise and its crisis responses to date are any guide, Europe will emerge from its current turmoil not only with the euro intact but with far stronger institutions and economic prospects for the future.

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