Financial Times
October 9, 2011
If the optimum is not attainable, we are tempted to settle for the second best. The optimal response for the eurozone would be to turn it into a fiscal union. But it might not happen – or not in time. In that case, the question naturally arises: what would constitute a minimally sufficient solution to the crisis?
There is an emerging consensus that bank recapitalisation lies at the heart of any solution short of a fiscal union. Few would claim it is sufficient. It would have to be somehow embedded into a system of cross-border financial insurance. Member states would remain sovereign, but the eurozone would make sure that all systemically important banks are properly capitalised, supervised and, if necessary, forced to close or merge. For this to work, all systemically relevant banks would have to come under the eurozone’s umbrella, not just those operating across borders.
In such a minimal system, cross-border transfers would still occur, but would be limited to supporting the financial sector. Member states would retain full sovereignty – subject to a common set of fiscal rules. If imbalances arose that destabilised the financial sector, the eurozone would provide effective insurance against cross-border spill-overs. Such a hypothetical set-up reminds me of a debate among central bankers during the credit bubble: should monetary policy prick bubbles, or mop up the debris afterwards? Our minimal solution mops up. The chaos in the eurozone would continue, but at least there would be some insurance at the end.
If the eurozone had adopted this approach in October 2008, right after the collapse of Lehman Brothers, it might just have worked. We would still have had the Greek and Portuguese crises, but Ireland, Spain and Italy might have been spared. Then again, it might not have worked. I can think of four reasons why it will not work today.
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