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December 08, 2011

European reforms are not enough, joint liability needed

Economist magazine - the proposed tightening of EU rules will not be enough to solve the problem. The odds of deterring a malfeasant country with fines, however semi-automatic they may appear, are slim. And the flouting of fiscal rules was not the only, or even the main, cause of the problem in the first place. Today’s crisis is less about fiscal profligacy than about investors’ fears for the euro’s sustainability and their flight from peripheral assets. In the short run an obsession with austerity could make matters worse by deepening recession. And without a framework for common financing, investors’ confidence will not return.




On this score the Merkozy vision offers nothing. Mrs Merkel persuaded Mr Sarkozy to rule out jointly issued Eurobonds. He got her to water down the idea that private bondholders must take a hit whenever countries get into trouble. The hope seems to be that tough talk on fiscal discipline will be enough to persuade the European Central Bank that it should step in more boldly. Mario Draghi, the ECB president, has indeed hinted that a “fiscal compact” could elicit such help. But there is no strategy on the bigger question of how and how far euro-zone countries should go towards joint liability for some debts.

This is crucial. The past ten years provide ample evidence that fiscal rules alone are not enough (and if you want to be really scared, look at Europe’s experience in the 1930s of monetary rigidity without a lender of last resort—see article). If, however, new stricter rules were combined with some form of joint liability, then there would be a reward for good behaviour and also a credible sanction: any country that overstepped its fiscal limits could not benefit from Eurobonds.

That would still leave a lot of other things to do, including structural reforms to boost competitiveness and the creation of a truly European banking system. But the core of the solution has to be the link between good behaviour and joint liability. Otherwise this will be just another much-ballyhooed summit that fails to save the euro.

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