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Why stricter rules threaten the eurozone

November 26, 2011 Comments off

Why stricter rules threaten the eurozone (PDF)
Source: Center for European Reform

On October 27th, European leaders agreed a ‘comprehensive solution’ to the eurozone debt crisis at an emergency summit in Brussels. The back-slapping that followed the summit was more wearied than usual – and the euphoria even shorter-lived. Within days, the agreement lay in tatters, as Italian borrowing costs surged above their pre-summit levels and markets began to contemplate the prospect of a disorderly Greek default and exit from the eurozone. Given the political chaos in Greece and Italy, it is tempting to conclude that a workable solution to the eurozone crisis was foiled by the dysfunctions of Mediterranean politics.

This essay argues that this seemingly obvious conclusion is unwarranted. The most that can be said is that Greek and Italian politics have made a bad situation worse. For the reality is that the eurozone’s comprehensive solution was nothing of the kind. True, eurozone leaders finally accepted what they had spent two years denying: that the Greek government was insolvent and would need to write off more of its debts; and that many banks were undercapitalised. But the comprehensive solution did nothing to correct the eurozone’s institutional flaws, or to reverse the increasingly perverse and self-defeating policies that the region is pursuing.

European policy-makers have been reluctant to concede that the eurozone is institutionally flawed. Even now, many assert that the crisis is not one of the eurozone itself, but of errant behaviour within it. If certain countries had not broken the rules, they argue, the eurozone would never have run into trouble. The way to restore confidence, it follows, is to ensure that rules are rigorously enforced. These claims are wrong on almost every count. It is now clear that a monetary union outside a fiscal union is a deeply unstable

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