The European central bank is a bank of banks but not a bank of states. This reduces the capabilities of member states to finance deficits. The role of the central bank to cope with the debt crises is institutionally more limited than in most other Western countries. The European Stability Mechanism has not enough financial power to bail out all distressed countries in the Eurozone. Eurobonds could increase lending capacities but would require a change of the European treaty, which is not in sight. They violate the no bail out clause of Art.125 of the Treaty on the Functioning of the European Union. The policy option is therefore debt restructuring of distressed countries and a bailout of financial institutions to avoid conflagration. This option would also shift some of the burden to creditors outside the Eurozone rather than to shift all risk on the people in solvent countries within the Eurozone.
JEL classification: G01, K33
Keywords: Euro, European debt crisis, European Central Bank, European Stability Mechanism, Debt restructuring, Sovereign insolvency, no bail out clause, Eurobonds
1. Why the Euro?
What is the economic rationale for the Euro? Some economists, Paul Krugman the most prominent among them, maintain that there is no rationale at all and view the Euro as a purely political and even romantic project for a disparate economic zone for which a single currency fits like the saddle on the cow2. If they are right, the Euro cannot and should not survive and hence the best strategy to end the current crisis would be to reintroduce national currencies. This would allow troubled countries to devaluate their currencies and thus regain international competitiveness.
However others, including Barry Eichengreen, one of the most knowledgeable observers of the European Union and its financial architecture think differently. In his article in the Journal of Economic Literature Eichengreen maintains that the introduction of the Euro was a consequent move after the establishment of the single European market. The European Union is not just a customs union but also a free market for services, capital and labor. The European treaties, the large body of secondary law and the decisions of the European Court of Justice have removed even the most remote barriers to the entry of national markets. No other collection of states has achieved this depth of market integration. The downside of this is an inherent vulnerability to sudden exchange rate changes in member countries, which can have major disruptive effects. This consequence of the single European market led to the introduction of the European exchange rate mechanism with almost fixed exchange rates as early as 1979. But with different inflation rates within the EU this mechanism was unstable. In 1992 both Britain and Italy heavily devaluated their currencies. This led to disruptions in the industries of other member states with huge layoffs of workers and a devaluation of the capital stock in export as well as import substituting industries. The consequence of this experience was the decision to take the risk of a common currency, in which such disruptions for investors and workers cannot occur3. Without the Euro it is questionable whether the deep market integration is sustainable. It might have to give way to a form of integration closer to what we have in the GATT/WTO framework. Just to illustrate: In Greece a newly appointed schoolteacher with a University degree currently earns a salary of little less than 1000 Euro per month and 80 per cent of employees in the public sector earn between 1000 and 15000 euros4. Assume that Greece would reintroduce the Drachma and devaluate it by 50 per cent as analysts forecast for that scenario. The salary would then decline to less than 500 Euro per month. This might lead to massive emigration like in neighboring countries Bulgaria and Romania, or in Poland, which are EU member states but not part of the Euro zone. …