One of the most interesting set of questions to arise out of the Greek crisis in the eurozone is whether – and, if so, what – institutional changes are needed to make it easier to manage disarray of this kind.
Some would argue that there is really no problem. When countries within the eurozone get into difficulty, they are supposed to look after themselves. The European Central Bank should continue to look at the performance of the economy as a whole. Meanwhile, given the “no bail-out” provisions of the treaty, each country must be on its own. If a country cannot raise the money it needs to finance its government, it has no choice but to raise taxes, cut spending and, in extremis, restructure its debt. The latter is likely to mean a deep recession, not least because the private sector is likely to be badly affected by a sovereign default. This would be particularly true for the financial sector.
Yet others would argue that the eurozone is unlikely to survive such shocks. Countries that default may become politically unmanageable. Some might be tempted to leave the eurozone altogether. Again, many would argue that this would be no bad thing: let those who cannot stand the heat get out of the kitchen.
The question I want to raise is whether institutional changes might make the eurozone work better and, if so, what they should be. Here are some possibilities.
First, there could be the creation of a European Monetary Fund (EMF) to manage the liquidity problems of countries in difficulty. This is already widely discussed. The argument here might be that, without one’s own central bank, a government depends on markets. But this creates the danger of “multiple equilibria”. That is fundamentally the same danger as a run on a bank, but this would be a “run” on a country. By offering finance to a country that would, in fact, be solvent in the long run, if helped, such a fund might reduce the damage done by crises. At the same time, given the difficulties in distinguishing illiquidity from insolvency, this idea might also just end up as a series of costly bail-outs. Indeed, many would argue that this is exactly what is happening in the case of Greece.
Second, there could be an insolvency procedure for eurozone member countries. An alternative to an EMF might be an orderly procedure to putting a country through bankruptcy. I understand that US states can be put into receivership. When she was at the International Monetary Fund, Anne Krueger put forward such an idea for an insolvency procedure for countries. Within the eurozone, where countries are no longer fully sovereign in monetary affairs, such a procedure might be helpful.
Third, there could be an EU budget that provides automatic transfers to countries in difficulties. In existing federal unions, fiscal transfers occur automatically to areas in difficulty, because central government finances things like unemployment benefits, child care benefits, pensions and even essential public services. This does not happen in the eurozone. So when a country is in deep difficulty, there is danger that the resulting collapse will be very deep indeed. An alternative might be to recognise a degree of mutual responsibility, via a large central fund, to be supplied automatically, when countries fall into exceptionally severe recessions.
Fourth, there could be a council of ministers, with the right to make decisions binding on member states, by qualified majority voting, on economic policy. In other words, there would be a genuine move towards political union, with more effective teeth on budgetary and other policies than those now available.
Maybe, other people have different ideas. Anyway, does the current crisis suggest that fundamental institutional reform is needed in the eurozone and what form should it take? I would be very interested in readers’ ideas on this topic. Below are Martin’s responses to readers:
Martin Wolf on default: A devaluation, which is a restoration of monetary sovereignty is, indeed, an alternative to an outright default. The default would then come via inflation. But, given the starting point, I would guess that default would come first and exit from the eurozone later.
Martin Wolf’s latest response: “It is widely believed that the single market cannot survive without a single currency. Indeed, this is stated below. Is the opposite not possibly the truth?”
Further update: Martin Wolf: “I increasingly wonder whether the best solution, for both sides, might not be for Germany to leave the eurozone (presumably with the Netherlands and Austria).”
Update: Read Martin’s first response to readers’ views on the eurozone discussion
