If the weaker eurozone economies abandoned the single currency, they would grow faster. The countries remaining would also benefit from the ending of an unhappy marriage
I’ve long argued that the eurozone’s weaker countries stand to benefit from abandoning the single currency. Rather than undergo an endless process of retrenchment inside the euro, they could grow much faster following a nominal devaluation outside the zone.
This would not just benefit the peripheral countries, however. The core countries stand to gain from weaker countries abandoning the common currency as well.
Core countries have two main courses of action they could pursue instead of the current approach of buying time with bailouts, longer-term refinancing operations and firewalls for the periphery.
The first option would be to pull the plug on the weaker countries, cutting off their funding and letting them fend for themselves. This would be a disaster for all parties, causing the crisis to spread like wildfire to the core. It is clearly not on the table.
Alternatively, the core countries could keep the peripheral countries on life support indefinitely, effectively turning the core-periphery relationship into an endless unhappy marriage.
To maintain such an unhappy marriage, the eurozone’s core countries would need to agree either to unlimited fiscal subsidies for the weaker countries through joint and several liabilities (such as Eurobonds) or to fiscal transfers. But Eurobonds can only emerge once political union and a pooling of assets have been achieved in the eurozone.
This is a long-term process, and there is very little chance that European leaders could achieve this in the timeframe necessary to keep the weaker countries in the common currency area. More likely, the eurozone’s unhappy marriage of core and periphery would involve creating a fiscal transfer union. This is an extremely risky and expensive venture, however.
Weaker countries would be disincentivised to undergo the difficult and painful task of rebalancing their economies if they knew they could turn to the wealthier countries for hand-outs instead. Transfers to the weaker countries are already vehemently opposed in the stronger, wealthier countries of the core. Furthermore, if the core countries were to provide all of the weaker countries with unlimited fiscal transfers, the core countries’ own balance sheets would become impaired and they would end up requiring bailouts themselves.
While the introduction of Eurobonds is too long-term a project to be completed in time to prevent the exit of some weaker countries from the eurozone, such exits from the periphery would make it easier for the remaining core countries to create joint and several liabilities.
The eurozone’a core countries do not trust in the fiscal responsibility of their peripheral counterparts. This was highlighted by the agreement of the fiscal compact, an initiative spearheaded by Germany to impose limits on the fiscal imbalances member states are allowed to accrue.
European leaders touted the fiscal compact as an early step towards fiscal union, but at the time of its agreement it represented nothing of the sort. It was an attempt to get the weaker eurozone countries to mimic Germany’s fiscal dynamic, thereby placing the entire onus for adjustment onto the periphery and ensuring that drastic fiscal adjustment would drive the weaker countries deeper into recession.
Given Germany’s obsessive insistence on fiscal responsibility as a pillar of the eurozone, the exit of weaker countries from the common currency area could provide the impetus for the stronger countries to move towards creating a true fiscal union.
Currently the core countries are unwilling to pool liabilities with the weaker countries because of concerns that they will be subsidising those countries forever and will therefore see their borrowing costs rise. But if weaker members are lost, the smaller eurozone that would result would consist of countries with a greater reputation for fiscal responsibility.
Such a change in the profile of the membership might lead the strongest, wealthiest countries to become less opposed to issuing Eurobonds and to finally take the necessary steps to establish a fiscal union. The result could be a smaller but much stronger currency area.
Megan Greene is head of European economics at Roubini Global Economics. This post first appeared on the Euro Area Debt Crisis blog
