Wednesday, July 20, 2011

A credible commitment for the Eurozone

by Thomas F. Cooley and Ramon Marimon


July 20, 2011

The sovereign-debt crisis spreading through Europe is threatening the existence of the single currency. Meanwhile in the US, debt has been a problem for many states without threatening the US itself. This column proposes a way of preventing future crises in Europe by learning how policymakers in the US achieve fiscal prudence without loss of sovereignty.

The Eurozone suffers a serious sovereign-debt crisis exacerbated by a serious debt-management problem. The markets are telling us this loud and clear. There is also no shortage of economists saying the same thing (see for instance Tabellini 2011).

This week’s meeting of the leaders of the Eurozone (21 July) will tell us a lot more about how bad the management problem is. The meeting is supposed to provide a solution to the Eurozone’s debt crisis or, at least, to reach an agreement on the second international bailout for Greece. The latter was already announced on 2 July but failed to satisfy one of its basic condition – the “voluntary” involvement of the European banking sector. Hopefully leaders understand that their game of chicken against the periphery has failed – pressure on periphery countries did not and cannot result in “miraculous austerity plans” and better repayment prospects.

It would be extremely dangerous to leave this crisis like unresolved over the summer, so Eurozone leaders need to come up with a non-fictitious agreement. But even a short-term agreement will not solve the underlying sovereign debt management problem.

The Eurozone needs a credible institutional commitment – the fiscal parallel of the euro.


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