Many cheered the news that the Czech Republic, the last holdout, earlier this month succumbed to pressure from the other 26 EU members and signed the Treaty of Lisbon. For those who've been fixated on the vision of a united Europe, the development brought their dream closer to reality.
Yet based on a Public Policy Brief from the Levy Economics Institute of Bard College, "Can Euroland Survive?" by Stephanie A. Kelton and L. Randall Wray, regardless of the political steps that have been taken so far, challenging economic circumstances remain a major stumbling block to full-scale integration.
From the Preface:
Social unrest across Europe is growing as Euroland’s economy collapses faster than the United States’, the result of falling exports and a weaker fiscal response. The controversial title of this brief is based on a belief that the nature of the euro itself limits Euroland’s fiscal policy space. The nations that have adopted the euro face “market-imposed” fiscal constraints on borrowing because they are not sovereign countries. Research Associate Stephanie A. Kelton and Senior Scholar L. Randall Wray foresee a real danger that these nations will be unable to prevent an accelerating slide toward depression that will threaten the existence of the European Union (EU).
Euroland’s economic performance has converged to one that is uniformly poor for all members (i.e., chronically high unemployment and slow growth), a situation consistent with nonsovereign nations’ relying on export-led (mercantilist) policy.Moreover, the capitalmarkets have doubts about the ability of member governments to cover their debts. Thus, bond yield spreads have widened during the downturn, indicating that liquidity and default risks are expected to rise, and that national defaults are plausible. The Federal Reserve (Fed) is lending to foreign central banks via swap lines and acting as the global lender of last resort. The authors maintain that the Fed does not face currency risk when it engages in overseas lending and that its actions have been a formof life support for Euroland. The question is whether there is sufficient political will for U.S. policymakers to continue this support as the Fed’s financial services explode.
The authors outline how fiscal policy operates in a sovereign nation that issues its own currency. Since a sovereign government spends by crediting bank accounts, its spending is never constrained by taxes or bond sales. There is no reason for rating agencies to downgrade government debt, since it is sovereign debt with no default risk. Moreover, a sovereign government can bail out its state and local governments. This option as it relates to the European Parliament is unknown, since the European Central Bank is practically prohibited fromtaking over the debts of member states.
The only way out of this crisis is to use sovereign power and ramp up government spending. Rather than shoring up investor confidence, spending increases in Euroland have fueled concerns about the impact on government debt levels and the future of the euro.Nearly half of allmember states are projected to breach the 3 percent deficit-to-GDP limit—debt that has to be purchased in (substantially tightened) private capital markets. The financialmarkets are expressing an unprecedented preference for German treasury issues, resulting in a dramatic widening of yield premiums against the bund. And in response to the threat of budgetary-related penalties by the EU’s executive arm, some states may simply abandon the euro.
The authors believe that the Maastricht Treaty does not constrain government spending, so any changes to this legislation would do little to increase fiscal freedom. This argument is based on the notion that financial markets (by pricing risk) are likely to discipline governments before the treaty limits are reached. When a nation is perceived to be a “weak” issuer, themarkets can effectively shut down its ability to stabilize conditions within its borders—a fundamental flaw that the authors have warned about since the euro zone’s inception. Unless these nations can avert such financial constraints—for example, by establishing a sizable EU budget and giving the European Parliament fiscal authority on par with that of the U.S. Congress—prospects for stabilizing the euro zone appear grim. Since such measures are likely to be politically, culturally, and socially difficult, a trend toward dissolution remains a possibility.
And from the Conclusion:
In some respects, allowing lower-income periphery nations to join the euro zone is similar to the United States’ encouraging Mexico to join a dollar union. On the one hand, we admire the willingness of the EU and Euroland to embrace its new members. On the other hand,we suspect that expansion hasmade the prospects for changing the structure of the union virtually impossible. Hence, there remains the possibility of a trend toward dissolution rather than greater unification.
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