The Greek crisis puts the currency's very survival at risk. Europe must now take long overdue action, says Joseph Stiglitz.
The Greek financial crisis has put the very survival of the euro at stake. At the euro's creation, many worried about its long-term viability. When everything went well, these worries were forgotten. But the question of how adjustments would be made if part of the eurozone were hit by a strong adverse shock lingered. Fixing the exchange rate and delegating monetary policy to the European Central Bank eliminated two primary means by which national governments stimulate their economies to avoid recession. What could replace them?
The Nobel laureate Robert Mundell laid out the conditions under which a single currency could work. Europe didn't meet those conditions at the time; it still doesn't. The removal of legal barriers to the movement of workers created a single labour market, but linguistic and cultural differences make US-style labour mobility unachievable.
Moreover, Europe has no way of helping those countries facing severe problems. Consider Spain, which has an unemployment rate of 20% – and more than 40% among young people. It had a fiscal surplus before the crisis; after the crisis, its deficit increased to more than 11% of GDP. But, under EU rules, Spain must now cut its spending, which will likely exacerbate unemployment. As its economy slows, the improvement in its fiscal position may be minimal.
Some hoped the Greek tragedy would convince policymakers that the euro cannot succeed without greater co-operation (including fiscal assistance). But Germany (and its Constitutional Court), partly following popular opinion, opposed giving Greece the help that it needs.
To many, both in and outside of Greece, this stance was peculiar: billions had been spent saving big banks, but evidently saving a country of 11 million people was taboo. It was not even clear that the help Greece needed should be labelled a bailout: while the funds given to financial institutions like AIG were unlikely to be recouped, a loan to Greece at a reasonable interest rate would probably be repaid.
A series of half-offers and vague promises, intended to calm the market, failed. Just as the US had cobbled together assistance for Mexico 15 years ago by combining help from the International Monetary Fund and the G7, so too the EU put together an assistance programme with the IMF. The question was, what conditions would be imposed and how big would be the adverse impact?
For the EU's smaller countries, the lesson is clear: if they do not reduce their budget deficits there is a high risk of a speculative attack, with little hope for adequate assistance from their neighbours, at least not without painful and counterproductive pro-cyclical budgetary restraints. As European countries take these measures, their economies are likely to weaken – with unhappy consequences for the global recovery.