Two of my favourite journalists have columns in today’s Financial Times that reach opposite conclusions on the euro crisis. John Kay takes seriously the ‘no bail-out rule’ of monetary union. Martin Wolf, in contrast, thinks that a ‘lender of last resort’ is needed to prevent liquidity crises in member countries.
Conventional wisdom holds that the eurozone problem is the adoption of a common monetary policy without a common fiscal policy. But a common fiscal policy is not necessary for a successful monetary union. No such agreement existed under the gold standard. Nor does one exist now between the US and the several countries – including China – which have pegged their exchange rate to the dollar. ….
Monetary union implies that areas with different economic conditions, growth rates and price expectations are no longer forced by markets to make compensating adjustments through currency devaluation. They must instead impose appropriate local policies towards wage growth, taxation and public spending. ….
But an excess of ambition extended membership of the eurozone to states that were neither willing nor able to accept the economic disciplines that replaced those imposed by the currency market. …. They will continue to be able to do so until creditors believe they will not be repaid – which would, if the new stability fund were to succeed in its objectives, mean that they could continue these policies for ever. The eurozone’s difficulties have been created by member states not markets, giving members more resources to fight markets makes things worse, not better.
The eurozone’s difficulties result not from the absence of strong central institutions but the absence of strong local institutions. A miscellany of domestic problems – rampant property speculation in Ireland and Spain, hopeless governance in Italy, lack of economic development in Portugal, Greece’s bloated public sector – have become problems for the EU as a whole. The solutions to these problems in every case can only be found locally.
John Kay, “Europe’s elite is fighting reality and will lose“, Financial Times, 26 October 2011.
What worries John is the possibility of ‘moral hazard’, a fear that bailouts will reward – thus encourage – bad governance and bad policies in member countries. Martin Wolf dismisses such fears. He wants the European Central Bank to become a lender of last resort for all member countries – at least for those that are solvent, but find it difficult to borrow at reasonable rates of interest.
Any effort by the ECB to be the lender of last resort that members need will start a firestorm of protest. People will argue that the central bank may lose money, exacerbate moral hazard and stoke inflation.
To the first of these objections, the right response is: so what? The central bank’s aim is to stabilise economies, not make money. Indeed, it is far more likely to lose money through half-hearted interventions than through forceful interventions that succeed. On the second, a clear understanding of the rules governing fiscal and economic policy is needed. You also need to decide whether a country is credibly solvent. Surely, Italy and Spain are. On the third, no good reason exists to expect an out-of-control inflationary process as a result of central bank monetary operations. The expansion of base money does not lead automatically to an expansion in the overall money supply, as you know well. Indeed, during the current crisis, the monetary base has become disconnected from the money supply in all big economies. That is what a financial crisis means.
Suppose the ECB did succeed in stabilising government bond markets in this way. It would also automatically stabilise the banks, since it is fears of sovereign defaults that are driving worries over banking insolvency. ….
The eurozone risks a tidal wave of fiscal and banking crises. The European financial stability facility cannot stop this. Only the ECB can. As the sole eurozone-wide institution, it has the responsibility. It also has the power.
Martin Wolf, “Be bold, Mario, put out that fire“, Financial Times, 26 October 2011.
Martin and John have divergent views, but would agree there should be no bailout for the government of Greece, which is clearly insolvent. I am sympathetic with the ‘no bail-out’ rule, but fear that strict application of it now would be very painful for the eurozone. The problem is that investors and some member governments failed initially to take the rule seriously.
