Preventing the Euro’s Next Crisis

LUXEMBOURG – Much dedication and energy are currently being devoted to institutionalizing a crisis-management mechanism for the euro area. This is a good and important goal. But a far more significant challenge – largely covered in the accompanying debate – is the need for crisis prevention.

At the European Union’s pre-Christmas summit, European heads of state and government agreed in principle to replace the Luxembourg-based European Financial Stability Facility (EFSF), which was thrown together practically overnight in May 2010, with a new, permanent European stability mechanism in 2013. That decision – and the speed with which it was reached – reflects the insight that the euro area’s institutional framework will remain incomplete until there are clear rules for handling financial crises.

But, while it is clear that the euro area will have solid and well-equipped quarantine wards should it once again be afflicted by financial contagion, a vaccine to prevent the infection would be far more effective. Unfortunately, developing one is receiving too little attention in the political arena.

The starting point should be the weaknesses of the euro area’s rules and regulations. The monetary union’s distinctive feature is the absence of a common state, despite the single currency. The euro’s architects were well aware that the participating states’ maintenance of sound public finances was a vital precondition for the new currency’s stability. A compromise was found with the Stability and Growth Pact (SGP) and its provisions for adhering to the Maastricht criteria, which sought to quantify the fiscal soundness of sovereign states without actually interfering with their budget and tax policies.