A big problem with the euro zone’s one-size-fits-all monetary policy is that it risks fitting nobody. That, indeed, was a key cause of the crisis. Early in the century, countries such as Spain and Ireland were booming, while Germany was in the doldrums. Setting interest rates at a level that worked well for the euro zone on average had the effect of inflating the Spanish and Irish property bubbles while pushing up wages so their economies became uncompetitive. When the bubbles burst, the damage was devastating.
The European Union is facing a crisis of legitimacy. This is evidenced in a decline in support for the EU among citizens in pretty much every member country. The most extreme manifestation is in the UK, where pressure is mounting to quit the EU.
Italy’s new prime minister, Enrico Letta, is making the best of a bad job. After February’s inconclusive election, it looked like Italy’s dysfunctional political system might drag the country further into the abyss. There was a risk that nobody would be able to form a government, new elections would be called and that even these would end in a stalemate.
One reason the euro zone is in such a mess is that it hasn’t had the courage to clean up its banks. The United States gave its lenders a proper scrubbing, followed by recapitalisation, in 2009. By contrast, the euro zone engaged in a series of half-hearted stress tests that missed many of the biggest banking problems such as those in Ireland, Spain and Cyprus.
It is perhaps too much to expect Britain’s Conservative-led government to lead any initiatives on Europe, such is the orgy of self-destruction in the party over whether the UK should stay in the European Union. But, insofar as David Cameron manages to get some respite from the madness, he should launch a strategy to enhance the City of London as Europe’s financial centre.
The austerity debate misses half the point. It is true that governments, especially in the euro zone, shouldn’t chase an austerity spiral ever downwards. But they can’t just sit on their hands. They must drive even harder for structural reforms.
Cyprus is no longer centre stage. Nicosia has agreed a 10 billion euro bailout deal with its euro zone partners and the International Monetary Fund. A visible bank run has been averted by stringent capital controls. International markets, which only ever suffered a mild bout of jitters, have calmed down.