The Key to Eurozone Stability Isn’t Monetary

The Eurozone debt crisis has raised important issues in the profession of economics. With regards to monetary integration much knowledge has been developed thanks to the crisis. Economist have virtually all rallied to the idea that  monetary unions exacerbate competitive imbalances. The Proof is in the widening gap of current accounts between the germanic like economies and the profligate periphery economies. Germany has never exported so much while the PIIGS have not suffered so much in a while. While the causes of the crisis are apparent to almost everyone (except maybe the Greeks) policy prescription differences abound. The prevailing view is to infuse massive amounts of liquidity into sovereign debt markets to stop the liquidity haemorrhage. The theory that the Eurozone is in a temporary liquidity crisis has strong proponents such as Paul Krugman or Roger Bootle. While Ireland has a strong growth profile and Italy does have a primary surplus that could justify monetary stopgap policies the problems of the other Euro profligates cannot be tidied over by temporary monetary measures because their issues are of a structural competitive order.

Once monetary policy impotence is accepted two policies approaches remain. The first is fiscal integration. A lot of economist advocate Euro bonds to alleviate market pressures on individual member finances. The obvious problems pertain to moral hazards. One of the causes of the crisis was that the reduction in sovereign interest rates because of decreased currency risk would induce profligacy. Such a phenomenon would be continued and compounded by Eurobonds. A fairness issue would also arise as lower debt countries would pay for the debt spending of others and AAA rated countries would actually pay heftier interest than they deserve. A problem in construction is also obvious. Eurobonds would be a substitute investment for sovereigns, unless Eurobonds replaced sovereigns entirely they would cannibalize demand for sovereigns and might actually help increase sovereign yields as German bunds have done to French Bonds today.

Instead of pooling liabilities to decrease individual sovereign risk, why not pool assets? This might be somewhat more palatable to German hawks. One way of pooling assets would be to federalize Unemployment Insurance. All members could pay into a fund that would back payments of insurance payouts. This would further effectively create an internal counter cyclical government spending stabilisation. As some states power ahead the transfers would automatically alleviate budgets in ailing economies. This already exists in Canada to great inter-provincial budgetary stability, the proof being that Quebec’s yields are at historical lows although the province has comparable debt levels to many PIIGS. Unfortunately as with all insurance schemes moral hazards subsiste, but the idea remains a good way to alleviate massive intra monetary union budgetary differences.

Fiscal integration however will not in the long term eradicate structural problems. The crux of the Eurozone problem is quite simply competitive differences. For a monetary union to survive in the long run productivity must balance out across its membership. Standardizing macro-prudential or regulatory frameworks across the zone is a good idea, but only when the policies standardized across the monetary union are good. Mis-regulation at a central level is worst than at the individual problem, imagine what the Eurozone sovereign debt crisis if everyone had emulated Greece or Spain’s policies. Diversity and regulatory competition is good so long as it leads to emulating of best practices. That countries aren’t emulating Germany is testament to political and not economic issues.

The only issue remaining is that of markets prevented from punishing political cultures conducive to bad policy. Greece has a political culture conducive to demagogy and fiscal populism. Markets are sending Greeks a message, “change your ways or suffer” that the European Union prevents this pedagogical process from unfolding is the real long term risk to Eurozone stability.