It is not surprising that fiscally challenged governments, like Italy’s and Greece’s, are in favor of euro bonds. If they could issue debt guaranteed by all their partners in the euro zone, they would not find it so hard to borrow money. They would then be under less pressure to do unpopular things like tighten their belts and reform their economies. It is also understandable that investors are clamoring for the introduction of euro bonds, because they could then recoup the losses on their investments in the fiscally weak countries’ debt.
But there is little chance of these bonds being approved any time soon by fiscally strong countries — led by Germany, the Netherlands and Finland. The politicians and public in those nations are worried about being drowned by other countries’ debt. The bonds would also blunt the incentive for other governments, which have borrowed too much money and whose economies are uncompetitive, to put their own houses in order.
Germany may be prepared to consider approving euro bonds once current debts are under control. But that, by definition, wouldn’t be a solution to the crisis. What is more, Berlin would agree to the issue of euro bonds only if other governments accepted strict rules on how much they could borrow. Mark Rutte, the Dutch prime minister, has even suggested that a budget czar should be appointed to ensure that countries don’t break the rules in the future. The czar would have the power to fine miscreants and, in the extreme, force them to increase taxes or quit the euro zone. Once the crisis is over, other euro zone countries may not find such a loss of sovereignty so appealing.
Conventional wisdom is that fiscal unity among countries in the euro zone — of which euro bonds would be a primary element — is needed to make the monetary union a success. Both euro-enthusiasts and euro-skeptics tend to share that view, although the latter group thinks of such unity as hell rather than heaven and would prefer the single currency to be dismantled. Both camps often argue that the main reason the euro zone is in crisis is because monetary union was started without fiscal unity.
But this conventional wisdom is flawed. Governments didn’t build up excessive debts because of the lack of fiscal unity. Rather, it was because they flouted the rules meant to limit borrowing and bond investors kept lending them money. There was a failure of discipline, both by the bureaucrats and by the market.
The least bad way forward is to make the discipline of the market more effective while giving struggling governments some help to make a transition to healthier economies. Allowing controlled default, which would inflict losses on investors, would be a valuable lesson that foolish lending has consequences. So far this has happened in only a half-hearted fashion. In Greece’s case, the “pretend and extend” approach has meant that the country hasn’t been allowed to go bust despite debts that could reach 167 percent of gross domestic product this year, according to Citigroup.
The chaotic policy making is causing unnecessary suffering. Despite that, the current approach has had one big success: Greece, Ireland, Portugal, Italy and Spain have finally started to embrace reforms they have shirked for years. Labor markets are being liberalized, pension ages pushed up, corruption rooted out and tax evasion tackled. More reform is required. Ultimately these changes will result in fitter economies, although there is no denying that the short-term outlook is bleak.
A combination of such supply-side changes with the option of controlled default in extreme cases isn’t just the best way of handling the current difficulties. It is a better long-term model for the region than euro bonds and fiscal unity.
Article source: http://feeds.nytimes.com/click.phdo?i=214cc015b71239059386fe145c292451
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