Colm McCarthy: Let’s write off monetary union and start afresh
This post was written by John McHale
Colm can correct me, but I think the title of the article does not capture the substance of the piece. I don’t think Colm is advocating abandoning the euro, but rather fixing its current inadequate structure, including putting in place an adequate banking union and effective lender of last resort to states.
From the article:
The broken Eurozone project needs two sets of policy actions. The first, for the long term, is a re-engineered monetary union designed to survive, which means a banking union and a more centralised system of macroeconomic management. The second, and more contentious, is a clean-up operation to restore prospects of economic recovery, especially in the growing list of financially distressed members.
To date, the performance of the Eurozone political leadership has been dismal, inviting unfavourable comparisons to the more decisive actions of the US Treasury and Federal Reserve.
The clean-up operation needs a coherent macroeconomic strategy at European level as well as an acceptance that the debt burdens remaining on several Eurozone members need to be relieved. The macroeconomic strategy should see a relaxation of fiscal consolidation in those countries which retain good access to bond markets, as well as a deliberately expansionary monetary policy from the European Central Bank. Some weakening in the external value of the euro should be seen as a minor concern. If the current growth standstill continues it may ultimately weaken anyway.
It is fashionable in Germany to argue that Europe needs greater political union, permitting a more centralised fiscal policy. If the Eurozone were already a single country, with a normal central bank and a counter-cyclical macroeconomic strategy, it would already be seeking to bolster aggregate demand as the US has been doing. The zone as a whole does not face an imminent inflation threat, does not have a balance of payments deficit and has public debt and deficit ratios no worse than those in the US, the United Kingdom or Japan. But it remains committed to a policy stance that is exacerbating the downturn, particularly in the regions of the Eurozone facing financial distress.
In addition to a relaxation of policy at Eurozone level, a pragmatic approach needs to be taken to the debt-encumbered member states. Greece will have to undertake another debt restructuring, perhaps fairly soon. Several other countries may be unable to carry the burden of debt which has been accumulated. A partial mutualisation of excess debt burdens is the other essential component in the clean-up operation, preferably on a no-fault basis. This will likely happen in a messy and politicised manner anyway. Better to accept that debt burdens in excess of some agreed threshold be addressed, through further haircuts for private creditors in some cases, some monetisation by the ECB and some mutualisation by Eurozone rescue vehicles. Peripheral states in trouble could expect to see a reversal of capital outflows, with a consequent reduction in borrowing costs. If this kind of clean-up operation requires treaty changes, so be it. The Irish Government is understandably wary of changes given the mixed record on getting EU-related referenda passed, but if treaty change is the price of a durable solution it should be considered on its merits.
One place where I might disagree with Colm is where he calls for “further haircuts for private creditors in some cases”. He is of course right that such haircuts cannot be ruled out; and, in the case of Greece, it is hard to see them being avoided. But it is a truism to say that it is the fear of such haircuts that leaves a country struggling for creditworthiness. Where there is a reasonable path through the crisis without such haircuts, the strategy should be to take the possibility off the table to the greatest extent possible. This does not mean there should not be relief on official debts. The Sunday Business Post piece “State edges closer to ECB deal on promissory note” (no link available) gives one encouraging note in today’s papers.