Tough Choices for a Troubled Euro



By Christopher Pissarides


One of the most exciting things about working at the London School of Economics is that we get to hear some of the world’s top thinkers and policy-makers. One occasion that I recall vividly is the visit of two great Europeans, Valerie Giscard d’Estaing and Helmut Schmidt. Europe had already completed the single market, the Berlin wall had fallen and the European Union was preparing to embrace new members and adopt a single currency.


I was completely sold on the idea. In 2000 I joined the Cyprus Monetary Policy Committee to help them bring the euro to the country and I worked on the teams in Britain and Sweden on the implications of the euro for the labour market.

Back then the euro looked like a great idea as a key next step in the process of European integration. But it has now back-fired. It is holding back growth and job creation and it is dividing Europe. The present situation is untenable: We need something similar to the rallying calls of Giscard d’ Estaing and Helmut Schmidt to restore the euro’s credibility in international markets. We need charismatic European leaders who will restore the trust that Europe’s nations once had for each other. Regretfully I do not see either materialising.


The euro should either be dismantled in an orderly fashion or the leading members should do what is necessary as fast as possible to make it growth- and employment-friendly. Continuing as at present, plodding along with ad hoc decision-making and inconsistent debt-relief policies (compare for example Cyprus and Greece; source of problem similar, solution very different) will get us nowhere. The policies pursued now to steady the euro are costing Europe jobs and are creating a lost generation of educated young people. This is not what the founding fathers had promised.


Doing the necessary to bring Europe back to life requires brave action in both monetary and fiscal policy. My fear is that we do not have the European leaders who can take this on. Angela Merkel and Francois Hollande are national leaders, not European ones. Wolfgang Schauble’s recent assessment of the Eurozone economy in London’s Financial Times makes one wonder if he ever realised that there is Eurozone south of the German borders.


The lesson taught by recent events in Europe is that the split between fiscal and monetary policy is untenable. Under present arrangements national governments need to recapitalise their banks and insure their deposits. This involves fiscal spending and build-up of debt. Poor bank supervision can lead to a deteriorating fiscal balance.


The monetary union that we got with the euro created the European Central Bank (ECB) as a central bank in charge of monetary policy but not supervision. Current plans to turn the ECB into a supervisory authority must go ahead speedily. We need a single supervisory authority which can dissolve banks when necessary, recapitalise them and insure their deposits. Anything less than that will engage national governments and will lead to more disasters.


The supervisory authority should be well-funded and not have to rely on transfers from governments and the International Monetary Fund as and when the need arises. If a Cyprus-style bail-in is the answer, the ECB should say so and face the consequences. As a Cypriot who experienced this first-hand I dare not think what these would be for the Eurozone.

We also need at least some central control of individual country fiscal finances. Fiscal transfers are already taking place, through the structural funds and the stability mechanisms. But large fiscal transfers are not palatable to European voters. With some control over country budgets they will not be necessary.


Many in Europe think that there is no future in Europe without fiscal union, i.e., without a US-style federal budget. Of course, fiscal union can do the job; the American West developed with a heavy dose of fiscal transfers from the East via the federal budget. But for present-day Europe I think this is going too far.



Fiscal supervision is necessary. The European Commission does some but it will be more credible if it is done by an independent body, a Brussels-based Fiscal Policy Council (FPC). Some fiscal transfers will always be necessary but they will be minimised if there are early warning signals from an independent FPC. More and more countries in Europe are finding that an FPC is contributing to domestic fiscal stability. We need one at central level to do a similar job but focus on the issues that concern the Eurozone as a whole. Its role would be complementary to that of the country FPCs and they should work with each other.



Fiscal austerity is destroying jobs. The rest of the world is coming out of crisis and taking on new challenges and Europe is being left behind, watching powerless the rising unemployment. The troika and national governments should be softer on austerity. Austerity has created a two-tier Europe: Germany and the smaller northern countries, for which the ECB monetary policy stance is about right; and the south, for which it is far too tight.


We need more investment in Europe. We should learn how to do our fiscal accounts better and exclude investment projects from the one-year horizons of national budgets. Because governments will be tempted to classify too much spending as investment, a European Growth Council is needed to evaluate which policies are growth-enhancing and which not and exclude growth-enhancing policies from the austerity budget. It can be as generous or as strict as required by the European Council; either way it will be a big improvement on the current situation.


Sir Christopher Pissarides is the 2010 Nobel Laureate for Economic Sciences. He is the Regius Professor of Economics at the London School of Economics, the European Studies Professor at the University of Cyprus and the Chairman of the Council of National Economy of the Republic of Cyprus.

Christopher Pissarides was a speaker at Friends of Europe’s tenth annual high-level roundtable The State of Europe: Tough choices for a troubled Europe on Wednesday, 2 October, which discussed the issues confronting the EU as it moves forward in a time of economic recession. Photos and videos of Pissarides’ contribution, along with the debates in their entirety, may be viewed at the link above.






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