Drawing on a recent paper by Nouriel Roubini, Martin Wolf lays out the options facing the euro zone with depressing clarity. (The Roubini paper is accessible here after an easy sign up for a trial subscription.)
Mr Roubini discusses four options for addressing these stock and flow challenges simultaneously: first, restoration of growth and competitiveness through aggressive monetary easing, a weaker euro and stimulatory policies in the core, while the periphery undertakes austerity and reform; second, a deflationary adjustment in the periphery alone, together with structural reforms, to force down nominal wages; third, permanent financing by the core of an uncompetitive periphery; and, fourth, widespread debt restructuring and partial break-up of the eurozone. The first could achieve adjustment, without much default. The second would fail to achieve flow adjustment in time and so is likely to morph into the fourth. The third would avoid both stock and flow adjustment in the periphery, but threaten insolvency in the core. The fourth would simply be the end.
While each of the options brings horrendous challenges, I think that there is fairly widespread agreement among economists that the first offers the best route to save the euro zone. The problem, of course, is the stonger members are wary, fearing inflation, a large contingent liability from their support of weaker members and severe moral hazard.
A modest suggestion/question: Should the government reprioritise its diplomatic efforts away from debt relief to work with like-minded countries to offer the strong countries credible mechanisms for tighter controls over fiscal policy as a quid pro quo for the stimulus components of Option 1?
Of course, efforts to put in place such controls are well advanced through the Euro Pact Plus. But these controls are seen as something being imposed on weaker countries, undermining the belief in Germany and other stronger countries that they will actually be respected.
Might a more more active embrace of the controls — but also making clear that the current restrictive monetary and fiscal policies in the core put the survival of the euro zone at unnecessasry risk — pay greater dividends?