The Eurozone’s Uncertainty Principle

TILBURG – If there is one thing that financial markets detest, it is prolonged uncertainty. But, since the eurozone crisis began, policymaking in the monetary union has become increasingly unpredictable. Early private-sector involvement in supporting the troubled eurozone countries was unexpected. The recent deal to save Cyprus, which includes forced losses on large depositors, was similarly surprising – and is threatening to damage further the eurozone’s already-delicate relationship with financial markets.

A previous proposal suggests that not even insured deposits of less than €100,000 ($129,000) are safe. Although Cypriot lawmakers decisively rejected the plan to impose a one-time tax of almost 7% on such deposits only a couple of days after it was presented, the damage has been done. People in Spain, Portugal, and other troubled eurozone countries now fear for their savings should their country need emergency loans from its partners.

Unpredictability could damage the eurozone even more than the crisis itself. Large-scale capital flight from the eurozone’s weaker economies would put them in dire straits, forcing their partners to provide even more emergency assistance, while capital flight from the eurozone as a whole could destabilize even its strongest economies, bringing the monetary union closer to a chaotic breakup. Moreover, by undermining confidence, unexpected measures can drive citizens to vote for populist leaders, adding political uncertainty to Europe’s challenges.

Paradoxically, the eurozone’s strict anti-exit policy is a major source of volatility. With no mechanism for orderly exit in place, the prospect of a chaotic departure by one or more countries petrifies financial markets and destabilizes the entire monetary union.