Rather than rethink their busted economic model, European leaders will drive Italy into an unmanageable situationby Ashoka Mody / November 16, 2018 / Leave a comment
We may be living through the making of another eurozone crisis. As with all crises, there are two central elements: the history and the tragedy itself.
The history is clear. The eurozone was an ill-conceived project from the start: for a motley group of countries, one monetary policy was a case of one-size-fits none. In particular, Italy needed the crutch of continuous currency devaluation, which became impossible once it gave up the lira. Italy is now stuck with ultra-low growth and the smallest of shocks can push it into recession.
The eurozone’s tragedy arises not just from the hubris of an enterprise that many warned would go badly wrong. It arises also from the mindset that came with the project.Early on, it became clear that member countries would not establish a fiscal union to transfer funds to countries in recession, to compensate them for the lack of their own currency and independent monetary policy. As I describe in my book EuroTragedy: A Drama in Nine Acts, a fiscal union was politically impossible: countries protected their core national sovereignty and refused to give up their tax revenues. In April 1998, chancellor Helmut Kohl stated bluntly that Germany would never pay the bills of other countries. If he had not made that commitment, there would have been no euro.
Given the impossibility of a fiscal union, the right response would have been to abandon the idea of a monetary union. Instead, at Maastricht in 1991, under German insistence, European authorities created fiscal rules—at whose core lay a 3 per cent of GDP limit on the budget deficit—as the basis for moving forward. National frugality, the accompanying narrative said, would ensure a “stable” eurozone.Economists immediately warned that the rules were deeply harmful. They enforce austerity precisely when a country is about to enter recession, making the recession worse, possibly much worse. Former European Commission president Romano Prodi famously said the fiscal rules were “stupid.”
Yet, lemming-like, European authorities insisted on them. The rules became a part of EU identity. Leaders believe that they are not “good” Europeans if they do not pay homage to them. They formed a deeply flawed monetary union and, for them, the rules and the narrative of “stability” justify that decision and underpin their claim that the eurozone will survive. Identification with…