Euro Crisis

Europe is still in the midst of a financial crisis, which shakes the euro to its foundations. European leaders have taken steps to save the euro, but are they sufficient en what are the implications? Tilburg University researchers participate in finding the best solutions.

For a leap forward Europe always needs a crisis


According to Sylvester Eijffinger, the only way to maintain our prosperity is to proceed with European integration.

The European Union embarked on its common currency project in 1998, long before its member states really had very much in common. "We knew this and there were warnings aplenty," says Sylvester Eijffinger, professor of Financial Economics at Tilburg University. "So the current euro crisis was inevitable. But the same applies to the solution, because there is no alternative to more intense cooperation. The costs will be high, but in ten years' time European integration will have reached a higher level." 

July 1, 1998: government ministers, central bankers, academics and top civil servants meet in Frankfurt for the establishment of the European Central Bank. "And for the crowning of Wim Duisenberg as the emperor of monetary Europe," smiles Sylvester Eijffinger, who was one of those present on that occasion. Besides being a university professor, Eijffinger is also a member of the Monetary Experts Panel of the European Parliament. In this role he advises the Parliament on the Monetary Dialogue with the ECB President. Those were special days, he says looking back, "Moments of tremendous optimism and hope."

Enlarged D-mark zone
Realism could not spoil the party mood. "Naturally, it was clear that not everything was properly regulated," continues Eijffinger.  "We knew from economic theory and from the example of the United States that a third pillar was necessary in addition to an internal market and a common currency for successful monetary union, namely a common budgetary and tax policy. Everyone knew this. But politically it was just not feasible. So everyone simply decided to continue along the path that had been chosen."

Should things have been done differently? "An enlarged D-mark zone would have been a better idea," thinks Eijffinger. "A more rational choice would have been to start with a group of economies in North-West Europe – Germany, the Benelux countries, Finland and Austria – that were focused on stability.  But politically, of course, that was never in the cards."

Shoved aside
The Economic and Monetary Union (EMU) was therefore a 'pseudo-monetary union'. The Stability Pact, which formally established the conditions for participation in the euro, had no real bite. This became apparent in 2004, for example. Eijffinger explains: "In that year Germany, France and Italy were all going through a bad patch economically and had no wish to be reminded of the strict European budgetary norms. So the three of them simply shoved the Pact aside."

There had already been signs of this a year earlier, according to Eijffinger. At that time he was working with fellow academics for a few months in Brussels, as a special adviser to the European Commission, on an assignment connected with ways of improving the Stability Pact. "We proposed two things," he says. "First, a method of calculating national budget deficits that would be less sensitive to cyclical trends and, second, automatic sanctions in the event of a breach of the rules."

Negative interest rates
It was the absence of budgetary discipline that ultimately crippled the southern eurozone countries. Wages rose faster than labor productivity. This caused inflation, which in turn undermined their competitive position. But, owing to the common currency, this was scarcely reflected in money and capital market rates until 2008. "This resulted in negative real interest rates for these countries," says Eijffinger. "So what do you do about it? You don't start saving. On the contrary, you incur debts. And that is what happened: on a grand scale and in both the public and the private sectors."

Labor mobility
So the roots of the euro crisis go right back to the introduction of the euro. An additional problem is that various adjustment mechanisms do not function properly. "Without monetary union you need exchange rates in order to adjust for the varying rates of inflation," explains Eijffinger. "In a monetary union you need other adjustment mechanisms: wage flexibility and labor mobility. Different rates of inflation within a monetary union are not a problem in and of themselves, but things become difficult if the alternative means of adjustment do not work. And that is the case right now. The potential for wage variances are still too limited and there is still insufficient labor mobility in Europe."

Fragmented
The way out of the maze is not really that complicated in an economic sense. "The complexity is of a political nature," says Eijffinger. "However you look at it, strict agreements about budgetary and fiscal policy and their enforcement amount to a transfer of sovereignty. And that is an unpalatable message for many politicians. But it's not the only possibility. We could revert to a fragmented Europe, but if we do it will be very difficult to maintain our prosperity. The United States, Japan and China are now the economic power blocs. Brazil and India are emerging economic powers and may possibly be joined by Russia in due course. Only as a bloc can Europe compete with them. As small, separate countries we would not stand a chance."

High price
Eijffinger believes that the sense of crisis will continue for a while next year. "Gradually it will ebb away in the course of 2012 and the following year," he says. "The introduction of the new agreements will be a protracted and painful process with seventeen different procedures in seventeen different countries. But ultimately Europe will emerge stronger. This is how it has always been. Europe needs crises in order to make a leap forward. The stagnation of the 1970s resulted in the establishment of the European Monetary System (EMS), and the crisis in the EMS in the early 1990s led to the introduction of EMU. The present euro crisis will result in political integration. In ten years' time Europe will be in a stronger position. The price will have been high, because the crisis will have lasted for five years or so and gone at the expense of growth, but there's simply no alternative."