MILAN – The late Milton Friedman said that a common currency – that is, a monetary union – cannot be sustained without a deep form of economic and political union. By this, he meant an open economy that ensures the free flow of goods, labor, and capital, together with a disciplined central fiscal authority and a strong central bank. The latter two are pillars of a strong currency. They work in tandem. But the other pieces are no less important.
The eurozone, currently wrestling with fiscal imbalance and sovereign debt risk, has a strong and autonomous central bank, but is fiscally fragmented and only partly unified politically.
Enter the Maastricht Treaty, which in theory imposes fiscal discipline by placing limits on government deficits and debt levels – clearly a structure designed to prevent free riding on the fiscal discipline of others. Maastricht was thus intended to prevent a situation like the current one in Greece.
It didn’t work. Eurozone sovereign debt turned out not to be homogenous with respect to risk.