Unless there is a dramatic and simultaneous shift in the politics of Italy, Germany and the European Central Bank, the collapse of the eurozone is all but certain. Neither Italy, Spain, Portugal, Ireland nor Greece will be able to maintain their membership in the eurozone, and maintain sustainability of their sovereign debt at current interest rate spreads. Something will have to give. The collapse of equity and sovereign bond prices is testimony that investors have lost trust in the process.
The extremely grave situation is the result of a multitude of factors: the original sin of a monetary union with no complement of an economic union; poor economic policies in several member states, including Italy; the German establishment’s collective embrace of neo-classical economics; and also market failure. There is no point now in assigning blame. We must look ahead. To solve the crisis will require a gargantuan political effort on all sides. The bad news is that neither Rome, nor Berlin, nor Frankfurt is politically prepared.
To get of out this mess would take three ingredients. The first is, of course, a eurobond, as an instrument of permanent interest rate convergence. On this point, Giulio Tremonti is right. As long as Germany maintains its opposition, the crisis will continue. The ruling of the German constitutional court, seems to rule out this prospect, and has significantly reduced the probability of a eurozone bond. Politically, opposition to eurobonds has also strengthened within Germany. Even Wolfgang Schäuble, the finance minister, and the most pro-European member of Angela Merkel’s cabinet, has firmly and publically ruled them out, or any other form of joint and several liability as a crisis resolution mechanism. This is very bad news.
The second ingredient is a partial loss of sovereignty. In European politics, everything is a contract. Just as Germany is not prepared for a Eurobond, Italy is not prepared for the deep political changes that a Eurobond would entail. Both will have to move. A transfer of sovereignty means that the main parameters of macroeconomic policy would be set outside the country. The size of the “manovra” would be determined externally, and even its distribution would be subject to negotiations with European partners. Under a eurobond regime, even distributional issues should be a matter of common concern, especially if countries choose economic policies that are detrimental to their ability to achieve growth and debt sustainability in the long run. While not necessary from the start, a monetary union will ultimately also require a common system of income and corporate taxes.
A third ingredient in such a system is a changed role of monetary policy. In the previous, depoliticised monetary union, the role of the central bank was clearly delineated. It was able to follow a simple inflation rule. But as a central bank in the world’s second largest economy, its task would become more multidimensional, as the task of Federal Reserve has become.
The crisis is certain to get worse, which may open up an opportunity for such a historic compact that would introduce a central eurozone executive in charge of macroeconomic policy, a eurozone bond, and a refined definition of the ECB’s mandate. I am not optimistic of any progress in the short term, given the extremely weak leadership in Germany and Italy. And in both countries, there will be no elections until 2013 that could force a regime change.
The needed changes are so complex that it would require the equivalent of a constitutional convention. We should be under no illusion that the introduction of these changes would involve serious changes to the European Treaties. It will have profound implication on the institutions of the European Union and their policies. A eurobond and its conjoint policy regime will take many years to agree, and implement.
The good news is that the eurozone does not need the eurobond itself to solve its crisis, only a credible process that leads to the creation of a eurobond eventually. Unfortunately, such a process is not imminent. I am starting to agree with Martin Luther: I hear the message well, but lack Faith’s constant trust.
The author is president of Eurointelligence, and an associate editor of the Financial Times.