Wednesday, February 18, 2009

The Beginnings of a Fiscal Transfer Mechanism for the Euro Area?

Dan Drezner recently noted the unexpected consequences of the financial crisis in Foreign Policy. Let me add one item to his list: the Euro area may move one step closer to being an optimal currency area. At least that is one way to interpret the news of Germany and France considering the bailout of other Euro nations. Such a move would amount to a large scale fiscal transfer in the Euro area and it potentially sets the precedent for creating an official fiscal transfer mechanism. What ten years of relatively stress-free Euro existence could not create may be brought about by the financial crisis. Of course, this assessment assumes the Euro area can survive the stresses of the current financial crisis, including the looming financial implosion of Eastern Europe.

Here is the story:
Germany, France May Face Bailout of Euro Nations Feb. 18 (Bloomberg) -- Germany and France may be forced to contemplate the bailout of entire nations rather than just individual banks as European government budgets buckle under the weight of recession.

German Finance Minister Peer Steinbrueck became the first senior policy maker to broach the topic earlier this week, saying some of the 16 euro nations are “getting into difficulties” and may need help. He went further today, saying Germany would show its “ability to act.” French officials are also concerned about market tensions as the cost of insuring Irish, Greek and Spanish debt against default rises to records and bond spreads widen.

The nightmare for Angela Merkel and Nicolas Sarkozy is that widening deficits will prompt investors to shun the debt of some countries, sparking a region-wide crisis. While few investors are yet forecasting any defaults, the mere risk of it may prompt the bloc’s two richest economies to ignore the European Central Bank and announce their willingness to come to the rescue.


Part of the problem policy makers now face stems from the fact the currency union does not have a single treasury and relies on the Stability and Growth Pact, which has been breached in the past, to keep budgets in check. Billionaire investor George Soros said yesterday the region’s economy must confront the problem posed by the lack of a Europe-wide finance ministry.

Here is Bloomberg TV on the story:

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