The End of the Eurozone Crisis

by George Hatjoullis

The EZ crisis is over. The Greece crisis continues but has no wider ramifications for the EZ. The EZ has confronted exit and survived. The loss of the irrevocable nature of EMU has haunted its architects since Maastricht but need do so no more. A country led by a party elected to challenge the loss of sovereignty to the EZ has capitulated despite having support for taking a time-out from the EZ. It did risk internal conflict by taking a time-out as the country is highly polarised politically, but the option was on the table. It is likely to experience internal conflict once the bill for staying in is presented in any event. Other potential rebel member states have seen the future.

The most important innovation however may be the idea of a time-out. This reconciles exit with irrevocability. An orderly temporary exit agreed by all parties is a solution that does not conjure up risks of contagion and the unravelling of the EZ. This innovation was met with cries of horror as it passed over the Twitter-sphere but it was the fundamental innovation that ended the EZ crisis. Individual member states may have crises but the institution of the EZ is now here to stay.

The institution of the EZ may yet see further development and modification. The current structure is built around fiscal and monetary orthodoxy. This is institutionally stable but will lead to economic instability that the institution of the EZ cannot counteract in its present shape. Only a federal structure will permit the EZ to move to a more flexible macro framework. It is unlikely to meet this challenge until economic conditions dictate. The analogy I have always used for the EZ (which I conjured as a Strategist at Morgan Stanley in the early 90s) is the EZ train. Maastricht got everyone on and locked them in. It proceeded slowly laying track as it went. It still has track to lay to complete the journey but it has covered enough ground to establish a viable railway network.

Membership for low productivity economies with limited domestic wage and price flexibility is going to be painful. This is because adjustment is asymmetric. High productivity economies will resist any upward nominal wage and price adjustment. This is the Weimar bias introduced by Germany. In many ways Germany is the problem. Low productivity countries will have to do the bulk of the adjusting. This will create pressure for population movements and new social problems for the EZ. However, this is a wider EU problem and is already a major issue and has allowed the rise of right-wing anti-EU-because-of-migration parties. This could be exacerbated by cyclical developments that fiscal and monetary orthodoxy cannot offset. In a sense the next challenge is already evident and a new crisis brewing.

The final phase of the EZ is federalism. It is also the point at which the EZ and EU must converge. The real existential crisis arises when the EZ arrives at this point. However, for the moment it is someway in the future. It is too far for financial markets to worry about. From the point of view of financial markets, the EZ crisis is over.