The Euro Area: Required Reforms

The current crisis is stimulating calls for reform of the overall governance structure for the euro area.  Wolfgang Munchau makes some proposals in his FT column today – you can read it here.

12 replies on “The Euro Area: Required Reforms”

The first reform should be to drop the aim that all new EU members should become EMU members. The boundaries of an effective political club are not necessarily those of an optimal currency union. Ireland and Spain are salutary illustrations of this as both are set to follow a decade of binge eating with a decade of crash dieting each induced by an errant monetary policy.

The irony of it all is that EMU was conceded by Germany to France as a price for France’s consent to German reunification. That reunification also featured a botched currency union, within Germany, which has seen enduring economic underperformance in eastern Germany as a consequence. The relative impoverishment under communism has been made permanent under democracy.

The Bundesbank were not fans of either the terms of German monetary reunification nor of EMU. It was reported that the Bundesbank’s then head, Karl Otto Pöhl, left that office in 1991 not because of the officially cited “personal reasons” but because of his disagreement with the terms of monetary union in Germany. The old Bundesbank may have been populated by crusty old toads. But they understood monetary economics. Not so their (and now our) political masters in the Bundestag.

Note also today’s Central Bank data which indicates:

1. a €20 billion jump in December in the ECB emergency liquidity support drawn down by domestic retail and mortgage banks; and

2. a €198 billion M3 figure (prior year €217 billion). By my estimates, Irish broad money is declining at a rate comparable with the decline in US broad money experienced after October 1929. N.B. the Central Bank estimates a significantly lower annual rate of decline, having reclassified monetary aggregates.

I find it difficult to believe in forecasts of real economic growth this year while real interest rates are so high and while broad money is declining at an annual rate significantly greater than our rate of (HICP) deflation.

I note that there was talk of a Europe-wide deposit insurance for banks, perhaps collected by a europe wide or global tax on banks. This is the same type of logic, i.e. insurance will save the day, that has got us into this mess. The amount of insurance will never be enough to solve the problem. Deposit insurance is relaly only a confidence inspiring device to avoid runs on banks which has been achieved. It will not prevent reckless banking. Pervasive risk aversion and the derivative products which were designed to sate it allowed people to act irresponsibly because there was an illusion of a safety net.

A global framework for bank resolution would be a better idea. That way bankers would have to assess the risks which their institution was fit to bear and take responsibility for that analysis. Similarly, creditors of banks would have to take responsibility for their decisions.

@Cormac Lucey
I believe the government, having terrorised so long about the IMF coming in and killing every one, decided to deliberately exaggerate the “recovery” that will occur in 2010. The sober reality – in contrast to the drunken spin – is here:

“Measured in terms of GNP this recession will last until 2015…

…The economy will be ‘recessed’ until it reaches the level at which it entered the recession….

….Even if the Government projections hold – unemployment and poverty will be hanging around for a while. In 2014, just as the economy is returning to 2007 levels (of GNP), unemployment is still estimated to be 9.5 percent. That’s after emigration has hollowed out significant sections of our skill and knowledge labour base. Yet, that will still be more than twice the level as of 2007.”

Even if nothing else goes wrong:
“We are in a hole – a deep hole. Hopefully, we’ll start to climb out sometime this year. But it will be a slow climb. We won’t get back to ground level for a few years yet.”

Are the so-called self-proclaimed progressives supportive of Ireland staying in the euro given all the digging (deeper) and climbing unemployment that will entail or do they take the position that it will just cost even more to get out?

Real progressives are liberal not socialist.

The efficacy of insurance surely depends on the assessment of risk? We have seen risk underestimated, ignored and denigrated as poor practices were not punished either by an increase in risk-based costs or by market vigilance (share-prices). In part this has been exacerbated (if not caused) by regulatory capture within national markets – the regulators are too close to the people they are regulating. As deposit insurance is, despite the poxy independent company veneer, part of the regulatory apparatus it is not it, per se, that has failed, but regulation.

So an at least partial solution would appear to be distant regulation. Since there isn’t anywhere in Europe that is distant from banks to be regulated, I think we should outsource operations to darkest Congo, preferably to an unair-conditioned building in a malarial so that regulators, in their stiff collars, are permanently irritable and never get the self-satisfied complacency that has characterised so much of the bureaucratic clap-trap that has passed for due diligence in the past number of years. At least we wouldn’t have the unedifying sight of the head honcho sailing into the sunset while his minions stay suckling at the national teat untroubled by their failings. Instead, like mista Kurtz, they failures will result in “he dead”.

@ Oliver Vandt

I wouldn’t agree with Michael Taft’s general political direction. But I’m afraid that I share his expectation that Ireland is set for “a long time in the hole”. We were outliers on the upside. We are outliers on debt levels. Sadly, we will be outliers on the downside.

I’m not sure that there is any great political calculus in the optimistic noises currently being made by official sources. Any gain in popularity that may be made now will only be at the expense of credibility later should those noises be proven mistaken.


My understanding of insurance scheme is that the insurers take on the risk because (i) they can calculate the likely pay-out and smooth out the cost amongt the insured parties and (ii) because they collect the premia they have the financial clout to bear the loss. These are the critical two factors in risk allocation:
1. Who is best placed to assess and minimize the risk, and
2. Who has is best placed (in terms of financial muscle and profit) to bear th risk.

This analysis works well with buildings insurance, car insurance, boat insurance (subject to excluding war and terrorism) and so forth.

However, it does not work for deposit insurance where there is a risk of systemic failure because:
(A) the deposit insurance scheme is not well placed to assess the risk of default which may arise from bad lending or fraud, and
(B) in the case of systemic failure, the deposit insurance scheme will never be sufficient to rescue all the depositors that need to be rescued to preserve the financial system.

Therefore, deposit insurance is no solution to systemic risk. The problems of “too big to fail” and systemic risk must be addressed with other solutions. That is not to say that deposit insurance is of no use. It is just not applicable to this problem.

Indeed, but how much of the failure of deposit insurance is due to the fact that the insurance schemes are run as semi-state at best and wholly owned state enterprises at worst?

“Therefore, deposit insurance is no solution to systemic risk. The problems of “too big to fail” and systemic risk must be addressed with other solutions. That is not to say that deposit insurance is of no use. It is just not applicable to this problem.”
Yep. That’s not really the point, though. Systemic risk is separate from deposit risk, but they are two sides of the same problem – on the left side ‘Reasons to let banks fail’, on the right ‘Reasons we can’t let banks fail’.

Each of the reasons that banks can’t be let fail has to be addressed so that there is no reason in that column. Each of them may require separate solutions, but the solutions must be integrated. It is unlikely that there will be a one-size-fits-all solution.

For sure, the risk to depositors and the runs on Northern Rock and the Irish banking system are reasons to believe that the existing system of deposit insurance failed. This prevented an orderly winding down of failing institutions and the imposition of panic guarantee measures. It is, as you point out, only one area, but to most people it is the key one as it is where they stand to most visibly lose.

@Oliver Vandt

Aren’t the people who estimated back in April that there was net emigration of 200,000 in 2008/09? If I recall, their estimate was based on mobile phone statistics. The actual figure published a few weeks later was 7,800 (all foreign nationals). Their methods of research would appear to leave something to be desired.

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