With the recent election in Greece, the country’s radical left Syriza party became the first anti-austerity party to win elections in Europe. The victory of Syriza prime minister candidate Alexis Tsipras has already cast doubts as to whether or not the country will continue its course on the austerity program imposed on Greece by its international creditors. Tsipras, who campaigned against the austerity measures, has won some supporters among the public in Italy and Spain who see his victory as a glimmer of hope for Europe’s most troubled countries.
Markets were initially shaken, but have since settled. Uncertainty remains as to how the European Union (EU) will negotiate in the showdown with Athens and what that will mean for the future of the EU. Drexel University’s Marco Airaudo, PhD, an assistant professor of economics in the University’s LeBow College of Business, weighed in on the debate elaborating on some key points that continue to impact the EU.
Economically vulnerable countries and a eurozone exit:
Exiting the euro isn’t a viable strategy, for any country, even those facing the most severe recession, according to Airaudo. “All these announcements—by some of the more vulnerable countries—of abandoning the euro to bring back national currencies and pursue a devaluation-based policy are non-credible threats. We will hear more of this during elections in southern European countries but this is just populism.
Exiting the euro, at this point, is a suicide. The benefits of devaluations—if any—might last for a few months but a country with serious structural problems—rigid labor markets, large debt, excessive public spending, etc.—like Greece or Italy, can’t keep devaluing its currency for years.
Politicians keep talking about the gain in competitiveness coming from devaluations, but never mention its costs. Prolonged devaluations bring inflation—eventually eroding people’s purchasing power— and create a hostile environment for foreign investors. Above all, they increase the costs associated with foreign debt. The long-term costs far outweigh the short-term benefits. The euro was not created in the most efficient way and many of the details were not considered, but now the EU needs to live with it.”
The EU as a monetary unit but not a fiscal one:
The EU has made a monetary union without thinking about a fiscal union, according to Airaudo. “Running a centralized monetary policy with much decentralized and uncoordinated fiscal policies can’t lead to stability,” he said. “These kind of ‘soft’ fiscal pacts have not worked as coordination devices, as they are hard to enforce. The euro was created with the federal structure of the United States in mind. However, there are some key differences: in the United States, the states do not have as much fiscal authority as sovereign countries in Europe, and fiscal policy (at least most of it) in the United States is decided in Washington. This is clearly not the case in Europe, where the European Parliament in Brussels mostly deals with regulations and competition laws.
I don’t see how the EU will be able to solve the euro issue once and for all without forming a fiscal/political union. However, all EU countries are reluctant to do this.”
Quantitative easing to stimulate growth:
In January the ECB announced plans to commence a quantitative easing (QE) policy through September 2016. Through this initiative, the European Central Bank announced it would buy 60 billion euros, or about $67 billion, worth of bonds each month until inflation in the eurozone rises to its official target of just under 2 percent.
This typically involves buying or selling securities in a short-term money market to lower or raise the interest rate prevailing in that market. In commencing a QE policy, the EU is following in the footsteps of American, British, and Japanese central banks all of which have undertaken QE in recent years.
The QE announced by the ECB will certainly bring some liquidity into a credit market that at the moment is very illiquid, according to Airaudo. “But again, this won’t solve Europe’s structural problems,” he said. “QE is a temporary and very unconventional policy, which has proven to be very efficient in bringing a country—like the United States—out of a deep recession. But it is not a magic wand. Countries with inefficient public spending will remain inefficient, while countries with rigid labor markets will continue to have high unemployment. It will just temporarily hide the problems of troubled countries. These problems will come back sooner or later.
The fact that some ‘fiscally responsible’ countries, like Germany, are not very favorable to an EU-wide QE is a sign of profound disagreement on what type of risk-sharing mechanism should be put in place in the EU. If countries do not agree on temporary risk sharing arrangements, how could they ever agree on more permanent ones that would come with a fiscal union?”
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