Tuesday, November 29, 2011

The emperor has no clothes

by Guido Tabellini


November 29, 2011

Last week's failed German government bond auction raised alarms across Europe; some say the Eurozone only has days to avoid collapse. This column argues that unless the Eurozone and particularly the ECB changes its anti-inflationary stance, the troubles will only get worse. The Eurozone is broken, and it is time to admit it.

As many had expected, the decisions made at the last European summit a few weeks ago were totally inadequate to halt the crisis. What can now be done to stop the spread of distrust?

The official response of German politicians is that leaders must reorder public finances and reform the economy. There is no doubt that this should be done, as it is unthinkable that the countries of southern Europe can get out of the crisis if they cannot recover the capacity for growth and restore public finances. But will this be enough? It is now increasingly clear that the answer is no.

National reforms are necessary but not sufficient to stop the crisis. The trouble is that the distrust is no longer aimed at individual countries; it is now aimed at the entire Eurozone. There is now a widespread belief that the very foundations of the euro are weakened by a defective foundation – an ‘original sin’.

In all advanced countries, the central bank's task is to safeguard financial stability by acting as a lender of last resort.
The ECB can only perform this task in the middle. It can provide liquidity to banks in difficulty, but it cannot do so for Eurozone governments.

The result is that countries with high debt are left at the mercy of the changing mood of the markets. If for some reason confidence falters, the debt burden quickly becomes unsustainable.


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