Nothing that has happened since has convinced me that the textbook was excessively pessimistic. On the contrary: it was far too optimistic. Life is strewn with banana skins, and when you step on one you need to be able to adjust. But the monetary union itself turned out to be a gigantic banana skin, inducing capital flows that pushed up costs around the European periphery. And adjustment – that is, currency devaluation – was not an option.
Furthermore, most textbooks of the time ignored the financial sector; thus, they ignored the fact that capital flows to the periphery would be channeled via banks, and that when the capital stopped flowing, bank crises would strain peripheral members’ public finances. This, in turn, would further erode banks’ balance sheets and constrain credit creation – the sovereign-bank doom loop that we have heard so much about in recent years. And no textbooks predicted that European cooperation would impose pro-cyclical austerity on crisis-struck countries, creating depressions that in some cases have rivaled those of the 1930s.
It has been obvious for some years that the “actually existing EMU” has been a costly failure, both economically and politically. Trust in European institutions has collapsed, and political parties skeptical not just of the euro, but of the entire European project, are on the rise. And yet most economists, even those who were never keen on EMU in the first place, have been reluctant to make the argument that the time has come to abandon a failed experiment.
A famous article by Barry Eichengreen pointed out that an anticipated EMU breakup would lead to the “mother of all financial crises.” It is hard to disagree with him. That is why economists of all stripes, whether or not they supported the introduction of the common currency, have spent the last five years developing and promoting a package of institutional reforms and policy changes that would make the eurozone less dysfunctional.
In the short run, the eurozone needs much looser monetary and fiscal policy. It also needs a higher inflation target (to reduce the need for nominal wage and price reductions); debt relief, where appropriate; a proper banking union with an adequate, centralized fiscal backstop; and a “safe” eurozone asset that national banks could hold, thereby breaking the sovereign-bank doom loop.
Unfortunately, economists have not argued strongly for a proper fiscal union. Even those who consider it economically necessary censor themselves, because they believe it to be politically impossible. The problem is that silence has narrowed the frontier of political possibility even further, so that more modest proposals have fallen by the wayside as well.
Five years on, the eurozone still lacks a proper banking union, or even, as Greece demonstrated, a proper lender of last resort. Moreover, a higher inflation target remains unthinkable, and the German government argues that defaults on sovereign debt are illegal within the eurozone. Pro-cyclical fiscal adjustment is still the order of the day.
The European Central Bank’s belated embrace of quantitative easing was a welcome step forward, but policymakers’ enormously destructive decision to shut down a member state’s banking system – for what appears to be political reasons – is a far larger step backward. And no one is talking about real fiscal and political union, even though no one can imagine European Monetary Union surviving under the status quo.
Meanwhile, the political damage is ongoing: not all protest parties are as pro-European as Greece’s ruling Syriza. And domestic politics is being distorted by the inability of centrist politicians to address voters’ concerns about the eurozone’s economic policies and its democratic deficit. To do so, it is feared, would give implicit support to the skeptics, which is taboo.
Thus, in France, Socialist President François Hollande channels Jean-Baptiste Say, arguing that supply creates its own demand, while the far-right National Front’s Marine Le Pen gets to quote Paul Krugman and Joseph Stiglitz approvingly. No wonder that working-class voters are turning to her party.
A victory for the National Front in 2017 or 2022, which is no longer unthinkable, would destroy the European project. Citizens of smaller eurozone member states will have noted the brutal way the ECB was politicized to achieve Germany’s goals in Greece, and the conclusion that the eurozone is a dangerous “union” for small countries will seem inescapable. If centrist parties remain on the sidelines, rather than protesting what has happened, the political extremists will gain further valuable territory.
As for economists like me, who have balked at advocating an end to the failed euro experiment and favored reform, perhaps it is time to admit defeat and move on. If only anti-Europeans oppose EMU, the EU baby could end up being thrown out with the euro bathwater.
An end to the euro would indeed provoke an immense crisis. But ask yourself this: Do you really think the euro will be around in its present form a century from now? If not it will end, and the timing of that end will never be “right.” Better, then, to get on with it before more damage is done.
Copyright: Project Syndicate, 2015.
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