WASHINGTON, DC – In July 2012, while addressing bankers in London, European Central Bank President Mario Draghi likened the euro to the bumblebee. “This is a mystery of nature, because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years.” But “something must have changed.” So the “bumblebee would have to graduate to a real bee. And that’s what it’s doing.”
Actually, for scientists, there has never been any mystery about how bumblebees can fly: they beat their wings about 200 times per second. They cannot possibly do this by flexing their muscles, but only by vibrating them. Think of the forces generated by a waving wand, and contrast them with those generated by a vibrating fork. The subtler force is much stronger.
So, is the eurozone ready to vibrate, rather than flex? Three steady shifts have occurred in Europe over the last three years. Flexible fiscal rules and rigid monetary policies have given way to the opposite. The same has happened in the case of tight labor laws and looser financial regulations, while European surveillance and global emergency mechanisms have undergone a similar change.
These shifts are sensible, and they should be sustained. The first shift is overdue, and the reasons are not subtle. One of the euro’s main problems since its introduction in 1999 has been that almost every national treasury flouted the monetary union’s fiscal rules. By contrast, the ECB was a model of rectitude, and its discipline helped everyone. Inflation dropped sharply, especially in the poorest countries. In 1995, inflation rates in Portugal and Greece were about three times those of northern Europe’s economies; by 2008, they were the same.
Freed from the worry of destabilizing exchange-rate adjustments that had plagued postwar Europe, trade increased dramatically, especially in the bigger economies. In 1990, Germany’s exports accounted for 25% of GDP; by 2008, they had almost doubled to 48%. Monetary stability reduced the cost of credit. Interest rates were almost 20% in Greece and Portugal in the 1990’s; by 2008, they were 2.5%, implying parity between Greek and German rates.
Anything that leads to lower inflation, more trade, and interest rates that are lower than growth rates is a good thing. So both the single market and the common currency have been good for Europe. But, by treating all sovereign debt equally, the ECB sent markets the wrong signal. As exchange rates in the eurozone were fixed and uniform, interest rates on government debt should have signaled differences in economic strength.
The small vibrations caused by constantly changing interest-rate differentials between, say, Germany and Greece, would have made the euro bumblebee fly. Instead, it was the strong breeze generated by the global boom that kept it aloft. The bumblebee is relearning to fly under its own power.
Institutions have evolved. The ECB is now capable of lender-of-last resort operations, like its counterparts in the US and UK. The European Union’s fiscal framework, though still far from unified, has progressed toward greater coordination. Today, Greece’s government cannot borrow at all, and Ireland must pay high interest rates, while France’s treasury might soon have to pay more, and Germany may be able to borrow even more cheaply. Market signals are working again, and that is the way it should be.
Moreover, eurozone governments have restarted the structural reforms that many halted in the early 2000’s. Current-account deficits in the eurozone “periphery” have been halved, the competitiveness loss accumulated during the last decade has been reduced, and important structural reforms – making labor markets more flexible and opening up industries sheltered from competition – have been implemented.
But a lot of adjustment remains to be completed. Europe needs better regulation of financial movements, which flow in the right direction, but are erratic, flooding Europe’s less advanced economies when finance is plentiful, and starving them of credit in times of stress. Financial flows could be stabilized through a combination of conservative national fiscal policies and region-wide regulation, so that they do not suddenly stop when growth slows. Here, too, small vibrations, not the flexing of powerful political muscles, are needed. Reforms will take time, but it should not stop us from recognizing what has been achieved during the crisis.
A third shift is in the geography of surveillance. At the start of the crisis, EU policymakers tended to view global financial institutions as sources of emergency funds, not as monitors of EU economies. Over the last three years, Europe has increasingly relied on global, as opposed to regional, governance. Surely, European leaders would rather keep both governance mechanisms and stability funds regional. But it may be more practical to have global financial and surveillance systems generate the vibrations that will make Europe dynamic, while drawing on EU sources of funds during emergencies.
This approach would also be more consistent with the advice that Europe has dispensed to others. At a seminar on the euro that we organized in Tokyo, an Asian expert observed that early in the crisis, Europeans did not practice what they preached during the Asian financial crisis. Europeans (and Americans) had advised Asians that they would never be able to enforce discipline on themselves, so the monetary, fiscal, and financial-governance mechanisms should be global, not regional. “I hope Europeans were wrong then,” was his message, “because otherwise they would be wrong now.”
Back in London, Draghi promised that the ECB would do “whatever it takes” to preserve the euro. Markets have rallied since, but the continent remains crisis-ridden. Europe cannot miraculously morph into a “real bee.” Nor does it need to. Instead, it should continue to take the small steps needed to allow market forces to discipline workers, corporations, banks, and governments.
The views expressed here are their own.
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