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The European credit crisis is as political as it is complicated. This breeds solutions in search of the problem. One of these is the ubiquitous idea that the euro’s woes can only be settled by fiscal union; the more rigid the better and no room for backsliding. The broad popularity of this idea is based around its appeal to those who have a preference for whips and chains and includes both Europhiles and Europhobes.
Formalising the hodgepodge
There should be a fiscal conversation at the EU level and perhaps a converging framework, tax code, and instruments, but there should also be space for countercyclical fiscal policy. There should also be a facility to address the dislocation of sudden stops – a stabilisation fund for governments that can be accessed for a long enough time to deal with liquidity issues but a short enough time to avoid procrastination, perhaps 12 months. During this time, the cost of funds should rise to indicate that this is not a long-term solution. It would need to be sized to cover the rollover of debt of half of the eurozone for over 12 months and some additional borrowing. That would make it around $2 trillion, or twice of what we currently have. And the central bank needs to be a lender of last resort for banks facing liquidity problems, with national governments taking over and where appropriate closing down in an orderly manner those with solvency problems.
Debt restructuring and even defaults should be countenanced. It is interesting that those countries recovering quickest from the recession are those where there have been extensive debt restructuring and write-offs. To balance the forces between debtors and creditors better, eurozone countries could even default and then use the stabilisation fund to tide them over before a return to markets within 12 months.
But above all else, we need to appreciate that the way to help a drowning man is not to put him in a straightjacket. Few benefits of a single market and single currency are lost by preserving countercyclical space in national fiscal and regulatory policy. One of the reasons why we strive to avoid financial crashes is that their first casualties are considered and balanced policies. Many of the seeds of the next crisis are sowed in the rescues of the current. Today, we must reflect that the euro’s long-term strength and salvation lies with a little less Europein fiscal and regulatory policy, not more.