In a study of the political and fiscal record of five federal states, economic historian Michael Bordo concludes that such a policy response is already unfolding in the European Union, as illustrated by the creation of a euro area financial rescue fund.
“History suggests that the creation of a union-wide bond market with a common bond may prove to be a successful way to finance increases in public expenditure to prevent the malaise experienced today in Europe,” Bordo wrote in a paper co-authored with Agnieszka Markiewicz and Lars Jonung.
German Finance Minister Wolfgang Schaeuble issued a fresh warning on Tuesday against the idea of euro bonds jointly guaranteed by the zone’s 17 members.
“The euro would lose its credibility as a stable currency,” he said.
But Bordo, an economics professor at Rutgers University in New Jersey, said the EU’s present fiscal arrangements robbed it of the means to tackle a rare but disastrous economic calamity.
In the face of a global crisis like the Great Depression, the US, Canada, Germany, Brazil and Argentina all increased the fiscal capacity of the central government and instituted a system of equalization payments, he said.
“This pattern suggests that the recent global crisis, which is the most severe one since the 1930s, may contribute to an increase in the central fiscal power of the EU, paving the way for larger transfers to the member states hardest hit by the crisis,” he wrote in a working paper for the National Bureau of Economic Research.
Another of the researchers’ conclusions will be music to Germany’s ears: that a no-bailout clause helps to avoid pressures leading to the disintegration of the euro zone, by exposing member states to the judgment of the markets.
“It is important to note that without a strict and credible no-bailout clause, the financial market mechanism is likely to fail as an efficient disciplining device on fiscal policy,” they wrote.
History can be only an imperfect guide to how the euro zone crisis will end for the simple reason that, as Bordo says, the bloc is the first case of a monetary union where monetary policy-making is in the hands of one central bank while fiscal policy is left with national governments.
But economists at UBS have also been examining the fiscal circumstances of earlier monetary unions and have reached a similar conclusion to Bordo.
“Our base case for the euro is that the monetary union will hold together, with some kind of fiscal confederation (providing automatic stabilizers to economies, not transfers to governments),” they wrote in a report.
“This is how the US monetary union was resurrected in the 1930s. It is how the UK monetary union, and indeed the German monetary union, have held together.”
The chances of a break-up of the single currency are low, not least because of the huge costs it would entail, UBS argued.
Sovereign and corporate default, collapse of the banking system and the loss of international trade would cost around 9,500 to 11,500 euros per person in the first year for a country quitting the union (40-50 percent of GDP) and then 3,000 to 4,000 euros a year over subsequent years, they estimated.
If Germany were to secede from the euro, the cost would be around 6,000 to 8,000 euros per person in the first year (20-25 percent of GDP) and 3,500 to 4,500 euros a year after that.
“These are conservative estimates. The economic consequences of civil disorder, break-up of the seceding country, etc, are not included in these costs,” the UBS report said.
