What Matters Is What We Do Next

Martin Essex of the Wall Street Journal flags Dimitri Papadimitriou and Randall Wray’s recent Policy Note on the eurozone, “Euroland’s Original Sin.”  The Note traces the root cause of the eurozone’s struggles, including the solvency issues and bank runs in the periphery, to a fundamental design flaw in its setup:  national governments gave up currency sovereignty by adopting the euro but retained responsibility for their own fiscal policy.

Essex chooses to focus on a footnote that quotes some early predictions by those associated with the Levy Institute, which is fine.  But it’s important to note a couple of things here.  First, the point is not that the euro project was predicted to run into trouble in general, but that in these quotations the problems were predicted to flow from a particular structural flaw:  the separation between fiscal policy and monetary sovereignty.  And this is important for reasons that go beyond a prescience contest.  The predictions serve as a useful guide for figuring out what needs to be done to save the euro project.

Getting it right isn’t about being able to say “I told you so,” but about having the credibility to say “here’s what should happen next.”  In this case, in the context of addressing the bank runs afflicting the periphery, Papadimitriou and Wray argue for the necessity of eurozone-wide deposit insurance backed by the creation of a serious EU-level Treasury.  Getting the diagnosis right also allows you to see which solutions won’t work:  using the EFSF/ESM to bail out banks, which was part of the plan emerging from the June summit, won’t solve the problem, the authors argue, since those bodies don’t have the unlimited firepower of a sovereign currency issuer.

If you think the eurozone is in trouble primarily because of the fiscal profligacy of lazy spendthrifts in the periphery, you will have a very different idea of what needs to happen next.  But if the fundamental problem in the eurozone is the divorce between fiscal and monetary sovereignty, then until this design flaw is fixed, “solvency” issues are bound to arise—even for a national government running a fiscal surplus (which is precisely what happened to Spain).

Essex cites a number of other economists who predicted trouble for the eurozone early on, and he invites his readers to come up with some other examples.  One example he doesn’t mention is featured in Papadimitriou and Wray’s Note:  Peter Garber’s crucial 1998 paper on the TARGET system.  Garber, prefiguring the recent bank runs, described the TARGET system as a “perfect mechanism to make an explosive attack on the system.”

And if you want early, here’s Wynne Godley—in 1992—in the London Review of Books (“Maastricht and All That”):

I recite all this to suggest, not that sovereignty should not be given up in the noble cause of European integration, but that if all these functions are renounced by individual governments they simply have to be taken on by some other authority. The incredible lacuna in the Maastricht programme is that, while it contains a blueprint for the establishment and modus operandi of an independent central bank, there is no blueprint whatever of the analogue, in Community terms, of a central government. Yet there would simply have to be a system of institutions which fulfils all those functions at a Community level which are at present exercised by the central governments of individual member countries.

Essex titles his post “Who Warned About the Euro First?”  But the point of the Policy Note (and even of the footnote that forms the basis of Essex’s post) is not to stake some claim on behalf of the quoted authors to being the first to get it right; nor even to claim that only those affiliated with the Levy Institute got it right (hence, Garber).  Whether you figured it out the month before Wynne Godley published “Maastricht and All That,” or last Thursday, the point is to understand as clearly as possible what’s going wrong in the eurozone and to use that understanding to help push for solutions—that’s where this conversation needs to go, and that’s where the Policy Note tries to take us (read it).