Way out of the debt crisis (Euro-English)

Here’s the link to the relevant press release of the European council. “Way out” probably translates (from Euro-English) to “The way out”… Not having really paid  attention to the existence of the council, I wondered : why not the European commission? My concern was assuaged : both presidents are pictured in the photo op

Trivialities aside, experts on the matter are at best lukewarm in sharing the optimism of the title although markets seemed to have welcomed it rather well. While they sort out the details in the coming days, let’s review why the Euro has so much trouble picking itself up.

It’s clear that even though the US and the EZ  were affected in similar ways by the 2007 financial crisis, the former has not had the sort of funding problem that peripheral countries and, by contagion, even some core countries are experiencing. Yet, in each case, the states share a common currency, the dollar and the euro, respectively. What are the fundamental institutional differences between the two continents that explain the relative robustness of the US relative to the EZ? The Fed has broad mandate whereas the ECB has a narrow mandate (price stability). Furthermore, the US has a significant federal budget, whereas the EZ have virtually no federal budget.

The EZ has made it very hard on itself, by design, to resist against a strong financial or economic shock. A fed budget results in automatic transfers between states that dampens what economists call asymmetric shocks. But although this was known, it was dismissed on the grounds that, with enough rules binding member states’ public finances (the SGP), and the market to discipline them, things would work just fine. It was also convenient politically, because sovereign nations of the EU weren’t ready to be superseded by a full blown central government in Brussels.

So while the debate revolves, in America, as to whether fiscal stimulus is a good thing or not, in the long term, the EU does not even have this option in the short term. Debt forgiveness, therefore, presents itself as much more pressing matter. The plan begins to recognize that by asking private investors (in fact, only banks, it seems) for a greater voluntary haircut on Greek’s debt than the one agreed to in July. Secondly, to make up for a fed budget, the Europeans have set up a Financial Stability Facility, but it’s a far cry from the real thing as it only deals with funding emergencies. Thirdly, some political drive to go beyond that stage is apparent under what is called Governance in the press release above.

A Keynesian economist worth following is Paul De Grauwe because he saw this coming over a decade ago. On the other side of the aisle,  this article seems worth reading.

2 Responses to Way out of the debt crisis (Euro-English)

  1. […] (EZ), only more acute than that of its peers. You may visualize it here. As discussed in our previous post on this topic,  the flaw in the design of the Euro-zone (EZ), is the absence of a federal budget […]

  2. […] reported on the EU summit to fix the Euro zone in October, which included a second bailout of Greece. We followed up with an […]

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