BERKELEY – Europe is again on the precipice. The most recent Greek rescue, put in place barely six weeks ago, is on the brink of collapse. The crisis of confidence has infected the eurozone’s big countries. The euro’s survival and, indeed, that of the European Union hang in the balance.
European leaders have responded with a cacophony of proposals for restoring confidence. Jean-Claude Trichet, the president of the European Central Bank, has called for stricter budgetary rules. Mario Draghi, head of the Bank of Italy and Trichet’s anointed successor at the ECB, has called for binding limits not on just budgets but also on a host of other national economic policies. Guy Verhofstadt, leader of the Alliance of Liberals and Democrats for Europe in the European Parliament, is only one in a growing chorus of voices calling for the creation of Eurobonds. Germany’s finance minister, Wolfgang Schäuble, has suggested that Europe needs to move to full fiscal union.
If these proposals have one thing in common, it is that they all fail to address the eurozone’s immediate problems. Some, like stronger fiscal rules and closer surveillance of policies affecting competitiveness, might help to head off some future crisis, but they will do nothing to resolve this one. Other ideas, like moving to fiscal union, would require a fundamental revision of the EU’s founding treaties. And issuing Eurobonds would require a degree of political consensus that will take months, if not years, to construct.
But Europe doesn’t have months, much less years, to resolve its crisis. At this point, it has only days to avert the worst. It is critical that leaders distinguish what must be done now from what can be left for later.
The first urgent task is for Europe to bulletproof its banks. Doubts about their stability are at the center of the storm. It is no coincidence that bank stocks were hit hardest in the recent financial crash. There are several ways to recapitalize Europe’s weak banks. The French and German governments, which have budgetary room for maneuver, can do so on their own. In the case of countries with poor fiscal positions, Europe’s rescue fund, the European Financial Stability Facility, can lend for this purpose. If still more money is required, the International Monetary Fund can create a special facility, using its own resources and matching funds put up by Asian governments and sovereign wealth funds.
The second urgent task is to create breathing space for Greece. The Greek people are making an almost superhuman effort to stabilize their finances and restructure their economy. But the government continues to miss its fiscal targets, more because of the global slowdown than through any fault of its own. This raises the danger that the EU and IMF will feel compelled to withdraw their support, leading to a disorderly debt default – and the social, political, and economic chaos that this scenario portends. In Greece itself, political and social stability are already tenuous. One poorly aimed rubber bullet might be all that is needed to turn the next street protest into an outright civil war. Again, help can come in any number of ways. Creditors can agree to relax Greece’s fiscal targets. The limp debt exchange agreed to in July can be thrown out and replaced by one that grants the country meaningful debt relief. Other EU countries, led by France and Germany, can provide foreign aid. Those who have spoken of a Marshall Plan for Greece can put their money where their mouths are.
The third urgent task is to restart economic growth. Financial stability, throughout Europe, depends on it. Without growth, tax revenues will remain stagnant, and the capacity to service debts will continue to erode. Social stability, similarly, depends on it. Without growth, austerity will become intolerable.
Here, too, the problem has several solutions. Germany can cut taxes. Better still would be coordinated fiscal stimulus across northern Europe.
But the fact of the matter is that northern European governments, constrained by domestic public opinion, remain unwilling to act. Under these circumstances, the only practical source of stimulus is the ECB. Interest rates will have to be slashed, and the ECB will have to follow up with large-scale asset purchases like those recently announced by the Swiss National Bank.
If these three urgent tasks are completed, there will be plenty of time – and much time will be needed – to contemplate radical changes like new budgetary rules, harmonization of other national policies, and a move to full fiscal union. But, as John Maynard Keynes famously quipped, “In the long run, we are all dead.” European leaders’ continued focus on the long run at the expense of short-term imperatives may indeed be the death knell for their single currency.
Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley.