ATHENS – The Cyprus bailout deal is a watershed in the unfolding eurozone crisis, because responsibility for resolving banks’ problems has been shifted from taxpayers to private investors and depositors. But imposing major losses on Cypriot banks’ depositors violates the deposit-insurance guarantee that forms part of the proposed European banking union, while the imposition of capital controls further erodes the monetary union’s foundations. So, is Europe chasing its tail?
Germany and the other countries of the eurozone core are signaling that debt mutualization within the monetary union is out of the question, and that bailouts of countries or financial institutions will be balanced by “bail-ins” of their creditors. Increased uncertainty concerning the safety of deposits will push up interest rates and deepen Europe’s recession, and may also trigger capital outflows from the eurozone’s weaker peripheral economies to the core.
The implications of this shift may be far-reaching. The German model for resolving the debt crisis and returning to internal or external balance relies on fiscal consolidation and structural reforms for the deficit countries. But, if all countries simultaneously attempt to improve their fiscal or external balances by cutting spending and raising taxes, all will fail, because each country’s austerity implies less demand for other countries’ output, in turn perpetuating both domestic and external imbalances. “Bailing in” creditors will exacerbate these trends.
Moreover, a deep and prolonged recession implies vanishing support for reforms, as governments fail to convince citizens that current sacrifice will ensure a better future. Privatization, market liberalization, the opening of closed professions, and government downsizing involve conflicts with powerful vested interests, such as businesses in protected industries, public-sector unions, or influential lobbies. Resolving such conflicts requires social alliances, which are invariably undermined by discontent, civil disorder, and political instability.