Against the backdrop of the ongoing sovereign debt crisis in Europe, CIGI convened a timely session at the annual conference of the Canadian Economics Association (CEA), on the challenges facing policy makers in the euro area and the rest of the European Union.
Entitled “The European Debt Crisis: Issues of governance, institutional design, economic policies and risk of contagion,” the session brought together a panel of expert researchers from the academic and policy communities. Paul Jenkins, CIGI distinguished fellow and former senior deputy governor of the Bank of Canada, chaired panellists Glen Hodgson, senior vice president and chief economist of the Conference Board of Canada; Christopher Ragan, associate professor of macroeconomics and economic policy at McGill University and David Dodge Chair in Monetary Policy at C.D. Howe Institute; Pierre Siklos, professor of macroeconomics at the Balsillie School of International Affairs and CIGI senior fellow; and Emil Stavrev, deputy division chief in the Research Department of the International Monetary Fund (IMF).
The session was opened by Jenkins, who asked panellists to consider if “rational policy making had been eclipsed by political gridlock,” if the right governance structures can be created in Europe so that the euro zone can work effectively in the future and what lessons Canadian policy makers can learn from the situation in Europe.
Stavrev, in presenting what he noted were his views and not those of the IMF, gave a broad-ranging overview of the situation in Europe, including updates on financial stress, bank delveraging, spillovers and intra-euro area imbalances. He concluded with policy recommendations that included better crisis management and containment, working toward a common financial stability framework and stronger fiscal integration complemented with ex ante risk sharing.
Ragan began by noting that the current crisis in Europe was about more than just fiscal problems, before offering a six-part policy solution to keep the euro zone intact:
- budget deficits and debt-to-GDP ratios must come down “very significantly” in the next 10 to 15 years;
- the drive for austerity in the short term is a mistake with the euro zone in recession;
- collective lending (either through the IMF or European Stability Mechanism) is needed to avoid the high interest rates bondholders would charge, and for the recapitalization of banks going forward;
- such collective lending will necessitate a need for collective debt guarantees, despite current objections from Germany to anything resembling euro bonds;
- a “grand bargain” is needed, in which Germany and others lend collectively and accept some form of euro bonds, in return for “problem” countries agreeing to a binding and enforceable set of fiscal rules; and
- the European Central Bank (ECB) must move fully into an expansionary policy setting — and even more so the more fiscal austerity continues.
Siklos began his presentation, titled “The Euro Needs Rehab...But It Will Survive,” by characterizing the situation in Europe as a political experiment gone bad and one that would thus need politics — and not economics — to save the common currency. He pointed to central failings from the outset of the European Monetary Union (EMU): too few escape clauses in the event of stresses in the system, the European Union’s weak oversight capabilities and a “tangled web” of bank regulations based on national financial market regulators operating under a single monetary policy. Chief among these failings was the ECB not being designed as a lender of last resort. Going forward, based on the view that a partial breakup is inconceivable, Siklos urged policy makers to realize there are “fast and slow thinking” approaches to the EMU, whereby the former might resolve the immediate challenge of keeping the EMU alive, while still requiring the latter for the larger structural reforms that are clearly needed.
The opening segment concluded with a presentation by Hodgson on “The Endgame for the Euro." In laying out three options, he noted all three were “unattractive” and come with “a heavy cost.” The first scenario, to which Hodgson assigned a probability of “under 50 percent and falling,” would see the EMU continue with the status quo while somehow managing a refinancing of the public debt in heavily indebted countries before implementing tough fiscal policies and reductions in wages and benefits aimed at improving competitiveness. Option 2 would see Greece leave the euro zone, a prospect Hodgson gave a probability of “50 percent and rising.” However, he cautioned that this scenario would be inherently “messy,” as there is currently no defined mechanism for a member country to leave the euro zone. The third option Hodgson put forward was that of Germany leaving the euo zone, something he saw as having a “less than five percent” probability. Hodgson described this as the “most attractive option economically, but [having] little chance politically.”
Whatever the outcome of the current crisis in the euro area, Hodgson stressed that Canada should continue its push for a formal free trade agreement with the European Union.
Comments from the audience about the prospects for successfully resolving the euro zone debt crisis were generally negative, calling for much more aggressive ECB action to expand the money supply and the need to let Greece default if there is to be any hope of turning the situation around.