Blog Post

An Agenda for Europe’s Worn-out Magicians

BRUSSELS – Europe’s leaders will meet again at the end of June. The question they must answer this time is not whether they can rescue this or that country, but whether they can rescue the eurozone – if not the European Union in its current form. To see why, just review the last 12 months. […]

By: Date: June 25, 2012 Topic: Macroeconomic policy

BRUSSELS – Europe’s leaders will meet again at the end of June. The question they must answer this time is not whether they can rescue this or that country, but whether they can rescue the eurozone – if not the European Union in its current form.

To see why, just review the last 12 months. In July 2011, Europe’s leaders agreed on a (limited) restructuring of Greek debt, while at the same time making financial assistance nimbler and cheaper. A year later, Greece remains on knife-edge.

Throughout last autumn, they agonized over the rise of Spanish and Italian bond rates, until finally the European Central Bank decided to administer pain relief in the form of large-scale liquidity provision to banks. But, despite the arrival of new, reform-minded governments in both Italy and Spain, the relief proved short-lived.

Then, last December, they agreed on a new fiscal treaty, a more robust financial firewall, and new resources for the International Monetary Fund, so that it could intervene on a larger scale. But, by early spring, bond rates for Spain and Italy were again approaching unsustainable levels.

Finally, earlier this month, they decided to devote €100 billion to help Spain clean up its ailing banks. The market’s reaction was to send Spanish government bond rates even higher.

Contrary to some perceptions, Europeans have not remained inactive over the last year. But they have lost their touch. Like aging magicians, they still try tricks that used to impress, but that fail to deliver results – or, worse, prove counterproductive. Meanwhile financial fragmentation within the eurozone continues; Spain, and to a lesser extent Italy, suffers a seemingly irresistible rise in borrowing costs; and political strains grow more visible.

One summit will not result in decisions that take months to prepare. But Europe’s leaders nonetheless have a chance to impress and start turning the tide, provided that they are sufficiently bold, comprehensive, and forward-looking. Here is a five-point agenda.

1.      Accept a limited renegotiation of the Greek program. The bomb has not been defused. While Greece was having two rounds of elections, its recession deepened and policy action stalled. The EU-IMF program is off track, and more focus must be put on growth. The EU should streamline and front-load existing transfers to Greece, and it should help trigger capital injection into state assets slated for privatization.

2.      Agree on a risk-sharing scheme for Spanish banks. To lend more to Spain’s government so that it can recapitalize the country’s banks adds to its debt burden and scares markets, which fear future debt restructuring. To use the partner countries’ taxpayers money to rescue Spanish banks is neither economically justified nor politically acceptable. The way out is that Spain should incur the first losses, and the eurozone’s financial-rescue fund, the European Stability Mechanism, should shoulder an increasing amount of the risk above a certain threshold (say, 5-10% of GDP).

3.      Map a scheme for a banking union. A banking union – consisting of common deposit insurance, supervision, and crisis resolution – would help to avoid the mutual contamination of banks and sovereigns, which is why the idea was endorsed at the recent G-20 summit in Mexico. But it is an ambitious endeavor that cannot be launched overnight. If Europe’s leaders want to show that they are seriously considering it, they should agree to launch concrete discussions on key parameters, giving their ministers a mandate to produce results by autumn.

4.      Explore options for Eurobonds. Financial assistance can conceivably help Spain, but not Italy. If Italy’s situation worsened, debt mutualization in one way or another would ultimately end up being the only alternative to large-scale default. But, while the European Commission has endorsed schemes for partial debt mutualization, there has never been a serious discussion about their conditions and implications. Europe’s leaders cannot decide anything at this stage, but they should task a group of “wise men” (and women) to evaluate and report on options by summer’s end.

5.      Create conditions for macroeconomic adjustment. Southern Europe needs to deflate to restore competitiveness vis-à-vis northern Europe. Yet, in addition to being horribly painful, domestic deflation threatens the sustainability of public and private debt. With lower nominal income and the same level of debt, the threat of default necessarily increases. Northern Europe should temporarily accept somewhat higher inflation, provided price stability is maintained in the eurozone as a whole. Fortunately, German policymakers have indicated that they understand this logic. Leaders must now forge a consensus around it.

Most importantly, the leaders should break the political deadlock. Germany does not want closer financial solidarity if not accompanied by political integration. France wants financial solidarity without closer political integration. Both camps have stuck to their positions for at least a quarter-century.

It is time to bridge the gap between them. The perception that Europeans can agree on abstruse technicalities, but not on essentials, is a fundamental reason why the euro’s magicians are losing their touch.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

May
25
14:30

How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

May - Jun
31-1
10:30

MICROPROD Final Event

Final conference of the MICROPROD project

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Italo Colantone, Maria Demertzis, Wolfhard Kaus, Javier Miranda, Steffen Müller, Verena Plümpe, Niclas Poitiers, Andrea Roventini, Gianluca Santoni, Valerie Smeets, Nicola Viegi and Markus Zimmermann Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event
 

Past Event

Past Event

[Cancelled] Shifting taxes in order to achieve green goals

[This event is cancelled until further notice] How could shifting the tax burden from labour to pollution and resources help the EU reach its climate goals?

Speakers: Niclas Poitiers and Femke Groothuis Topic: Green economy, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 12, 2022
Read about event More on this topic
 

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read article Download PDF More by this author
 

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article Download PDF More on this topic
 

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article More on this topic
 

External Publication

What drives implementation of the European Union’s policy recommendations to its member countries?

Article published in the Journal of Economic Policy Reform.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: Macroeconomic policy Date: April 13, 2022
Read article Download PDF More on this topic More by this author
 

Working Paper

Measuring the intangible economy to address policy challenges

The purpose of the first work package of the MICROPROD project was to improve the firm-level data infrastructure, expand the measurement of intangible assets and enable cross-country analyses of these productivity trends.

By: Marie Le Mouel Topic: Macroeconomic policy Date: April 11, 2022
Read about event More on this topic
 

Past Event

Past Event

Macroeconomic and financial stability in changing times: conversation with Andrew Bailey

Guntram Wolff will be joined in conversation by Andrew Bailey, Governor of the Bank of England.

Speakers: Andrew Bailey and Guntram B. Wolff Topic: Macroeconomic policy Date: March 28, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read article More on this topic More by this author
 

Opinion

The week inflation became entrenched

The events that have unfolded since 24 February have solved one dispute: inflation is no longer temporary.

By: Maria Demertzis Topic: Macroeconomic policy Date: March 8, 2022
Load more posts