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A European New Deal

FLORENCE/ANN ARBOR – The eurozone has reached a crossroads. European policy prescriptions have proven inadequate, and there is no consensus on the right balance of fiscal consolidation and economic stimulus – or on how much fiscal solidarity a functioning monetary union requires.

Disagreement over Eurobonds exemplifies the European Union’s current dilemma. Overstretched sovereign borrowers on the eurozone periphery argue that issuing government securities backed by all eurozone countries is the only way out of their “debt trap.” But, without common economic governance, northern Europeans contend, mutualization of debt would encourage free-riding by debtor countries.

In fact, both sides are right. So, in order to neutralize moral hazard, northern European countries seek a guarantee that their profligate peripheral neighbors maintain discipline, reflected in steps taken toward greater Europe-wide governance of national fiscal policies. Indeed, EU leaders are focusing on more European rules to discipline national governments.

But, even if fiscal discipline is achieved, it will not be enough to fortify the monetary union. Indeed, a country’s fiscal position depends on its broader economic environment and, in particular, on its trade balance. A monetary union cannot comprise only states running trade surpluses; hard times demand costly transfers.