Will the eurozone survive? Some observations

26/5/2016

By Wofgang Munchau

We would like to take this note from Simon Wren-Lewis as a backdrop to an observation we have made some time ago. The economics profession seems to be moving away from the idea that a monetary union requires some degree of political and fiscal union, so it is capable of surviving without it even in the long run. Wren-Lewis says that, in terms of macroeconomics, there is no obvious crisis that could lead to its demise. High unemployment will persist. This is a bad thing, but it won't end the monetary union. It is also terrible how the eurozone is treating Greece. But that again does not mean it will not continue. It all looks extremely suboptimal, but it is an equilibrium. Not a good one, but a stable one. He says the biggest threat to the eurozone is not economic, but political. The immigration crisis and the associated rise of the far right will mean that no one will risk further political union.

Another argument we are hearing increasingly often is that the problems of the eurozone can all be fixed through insurance, for example against large asymmetric shocks or banking crises. That again means you don't need a political union. Now, we understand that part of this rhetoric is intended to soothe the Germans in the hope that they find the world "insurance" less offensive than "eurobonds". For starters, do not underestimate the ability of the German establishment to identify a joint liability instrument whatever the name may be. Remember the "stability bond" episode, when people thought the solution to overcome German opposition to eurobonds is to call them by a different name? Insurance is of the same category. Insurance works because it is a binding contract, governed by law. Insurance between states is always an act of political will that has to be approved by a parliament. If an insurance payment was ever required, the payer will surely want some form of political union to ensure that the insurance contract is not legally abused by the recipient. In the end, you would still end up with demands for a political union even if you choose a minimal system of transfers, such as those based on insurance.

So it is not clear that a monetary union that refuses to be a political union can survive in the long run. Wren-Lewis mentions the political risks. But there are macroeconomic shocks, too, the eurozone is not equipped to deal with. A fiscal crisis in Italy, for example, which is not an impossible scenario on current trends, has no obvious solution since the ESM is too small to cope with a country the size of Italy.

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