The reason the European Union is currently facing roiling debt crises is that right now even running a primary surplus is no guarantee that your country won’t go bust. That’s because the European Central Bank is refusing to step up to the plate and act as a lender of last resort. The solution to the problem is for the European Central Bank to step up to the plate and act as a lender of last resort. Marcus Walker, David Gauthier-Vlllars, and Brian Blackstone report on a possibly significant development from French and German leaders that could create some light at the end of the tunnel. The idea is to “make budget discipline legally binding and enforceable by European authorities” including “centralized fiscal enforcement authority with power to seize control of national budgets.”
The first thing I want to be absolutely clear on is that this won’t solve the problem. At all. It’s as if your big plan to treat strep throat was to go grill some steaks because, hey, steak is delicious. That said, maybe your pharmacist is refusing to give you antibiotics and really loves steak. You can’t make antibiotics, but you can grill steak. So maybe you grill the steak and hope the pharmacist is interested in a trade. The bet here, in other words, would be that the ECB is only pretending to have a principled objection to acting as a lender of last resort. They’re just pretending to have such an objection because they really want the European Union to adopt binding budget rules. Give them the steak, and they’ll hand over the antibiotics. And maybe they will.
In terms of Europe’s actual economic problems, however, this idea will make things worse not better. The big problem with the Eurozone is that the underlying economy simply isn’t that integrated. The Portugese economy is very different from the Dutch economy, and Portugese workers face a lot of hurdles in relocating to the Netherlands or Finland where suddenly they’d be inconveniently illiterate in the local language. That means it’s objectively difficult for the European Central Bank to set monetary conditions that are equally appropriate for all countries. During the credit boom, the ECB pursued policies that were too loose for southern Europe’s economies. Then during the contraction, it’s pursued policies that are too tight for southern Europe. It’s not possible to target all the countries appropriately. The proposed continent-wide fiscal straightjacket will exacerbate the problem. If Eurozone-wide conditions warrant monetary policy that pushes Finland into recession, the new rules will mandate that Finland undertake sharp tax hikes and spending cuts that further deepen the recession. Thanks to balanced budget rules, American states already operate this way and it’s a pretty serious problem. The good news for America is that we have a federal government with the ability to smooth out some of the pro-cyclical impacts of state and local budget. Europe has no such thing.
UPDATE: Henry Farrell’s excellent review essay on the problematic evolution of European institutions (PDF) is very relevant here. Once again when faced with a political problem, the EU’s lack of legitimacy is forcing it to reach for a “techical” solution that will further undermine its legitimacy.