It has been a remarkable few months for the euro. The unemployment rate continues to rise, reaching a new record it seems month after month. Austerity continues apace even if the same shenanigans used to destroy the credibility of the Stability and Growth Pact (SGP) are once again resurfacing as some countries strain to keep their promise to reduce deficits as required by the new and improved SGP negotiated last year. Yet, since last August, when the European Central Bank introduced its Outright Monetary Transactions policy (OMT), effectively circumventing the Maastricht prohibition against the euro area central bank acting as a lender of last resort, calm has come over financial markets. In spite of the fact that Spain and Italy, in particular, struggle with massive debts, slow to negative growth and more recently scandal and elections that leave Italy possibly ungovernable, yields on sovereign debt in the southern periphery fell dramatically and remain considerably lower than at the height of the sovereign debt crisis.
The events of the past six months are all the more remarkable given that none of the much needed reforms in euro zone governance are any closer to being implemented than before the Greek crisis made its appearance in May 2010. There is precious little progress on a banking union although the ECB is preparing to take on a bigger role as the euro zone’s supervisor of major financial institutions. There is, equally, little evidence of solidarity among the finance ministers and heads of government in the euro zone or the EU nor a sense of urgency to propose or implement growth initiatives. Even the message of austerity, restructuring or rebalancing, however it is packaged for public consumption, is no longer the order of the day as each successive election produces greater divergences of views about the way forward for fiscal policy.
Now, however, the peace that enveloped financial markets in the euro zone is showing signs of being broken. EU ministers, with their fondness for meetings that last well into the night, have chosen to change the rules once again in their dealings with Cyprus, the latest member in the sovereign debt crisis club. Because the amounts needed to bail out the country seem astronomical given the economy’s size, the decision was taken to bail-in depositors by taxing their deposits, regardless of size, as one of the conditions for EU assistance with debt restructuring. Not surprisingly, in the hours following the announcement, depositors flocked to ATMs and their banks in an attempt to beat the imposition of the tax. Now it is also being revealed that domestic political imperatives led some (e.g., Germany, Finland) to favour taxing all depositors while others feared the consequences including uproar in Cyprus and demands to renegotiate the terms of financial assistance for that country. Those consequences have now materialized.
While it is arguable whether taxing all depositors is ‘fair’ and whether the EU’s decision might prompt a bank run elsewhere in the euro area, what the latest episode reveals is the inconsistency with which ‘conditionality’ is applied to economic reforms demanded, often by northern Europe. It is hard to avoid thinking that while some economies are ‘too big to fail’ others serve as object lessons for any member country that dares not to follow the party line when it comes to macroeconomic and financial policies. To be sure, there is a strong argument for tailoring reforms to recognize individual country needs — that’s what the IMF is for after all — but this is not the road taken. Instead, a crisis in some member state erupts and the rest of the euro zone economies find out how badly the economy is managed or how the financial sector has run amok, leading to a backlash and seemingly ever harsher conditions being imposed in return for financial assistance. It must be galling to many euro zone Finance ministers that Cyprus is one of the newest euro zone member (2008) but there is no acknowledgement that the events that have transpired over the past three years are due to the system’s neglect over how members practice governance in macroeconomic and financial policies.
Just as there was talk that the OMT might well have given the euro zone some breathing space to deal with its economic and governance issues, the latest events remind us that policy makers have not lost their ability to take two steps back every time they manage to take one step forward.