The European economic
crisis not only persists but
continues to get deeper despite the efforts of International Monetary Fund, European Central Bank and other multilateral agencies. Reason is a wrong diagnosis of the disease. It is believed that the main problem of Europe is the disconnect between monetary and fiscal policies. Monetary policies such as interest rates and liquidity in the money market of all members of the Eurozone are determined by the European Central Bank (ECB). However, every member country is free to determine its own fiscal policies such as tax rates and unemployment compensation. Problem is that the two policies are often working in opposite directions. For example, the ECB has followed a tight monetary policy in order to control inflation. However, countries like Greece have adopted an easy fiscal policy. They have increased expenditures on salaries of government employees and welfare programs such as unemployment compensation and health benefits. The loose fiscal policy requires the government to borrow large amounts from the markets. This is not possible in a tight monetary policy framework. The Greek Government has had to consequently borrow at high rates of interest. The interest burden has mounted and the Greek government has become insolvent. It is unable to repay its debts leading to an imminent default. Greece could have simply printed its currency and financed these expenditures had it been a master of its own monetary policy. Indeed, that would have led to devaluation of its currency but that would not lead to a crisis. The lenders would have lost value of their loans quietly and borne the same without demur. Greece has lost the option of devaluation and that can be held to be mainly responsible for the present crisis. In other words, the crisis can be attributed to the disjoint between fiscal and monetary policies.
Consensus has been reached among G-20 that the basic problem of Europe is this disconnect between a unified monetary policy and fragmented fiscal policy. European countries have committed to work towards a fiscal union. G-20 have decided to provide bailout though the International Monetary Fund with this understanding.
Well, attaining a fiscal union will not be that easy. It is like ceding sovereignty to a European Parliament. The National Governments will lose control over policies like tax rates, welfare programs and defense expenditures. Political difficulties aside, the question is whether even such a fiscal union will pull Europe out of the economic mess.
Will a fiscal union make Europe more competitive and pull it out of the crisis? Reply is possibly 'No'. Coordination between monetary and fiscal policies may help Europe manage its immediate problems but it lacks the teeth to solve the problem of loss of competitiveness which is rooted in high wages. It is in this perspective that one must read American Congressman Tom Coburn's statement : "We're throwing good money after bad down a hole that I think is not a solvable problem... Europe is going to default eventually, so why would you socialize their profligate spending." Coburn is planning to bring a legislation directing the US government to veto an expanded role for the IMF in Europe.
Vol. 45, No. 6, Aug 19-25, 2012