C. Fred Bergsten and Jacob Kierkegaard think Europe will pull things together and the Euro will not collapse. The frequent crises there in the last year derive from a game of "chicken" by actors trying to stick each other with as much as possible of the cost of averting a collapse; all actors recognize that whatever fraction they end up bearing, the cost to them of doing what it takes to prevent collapse, is much less than the cost of collapse, they say.
At The Monkey Cage, it's pointed out that games of chicken sometimes end badly. I think Bergsten and Kierkegaard are quite aware of this, but it's interesting that they think it's unlikely to happen in this instance. Their advice regarding Euro zone leaders, to "watch what they do, not what they say" is clearly worth remembering, as the events and words leading up to the ECB action on credit via European banks indicate.
For me, the threat of an actual collapse of the Euro, or of the European banking system, diminished greatly when the ECB proffered its three-year loans of 450 billion or so Euros to European banks last December. The banks used some of it to buy Euro area sovereign bonds (Bergsten and Kierkegaard claim that they were under pressure from the ECB to do that; I've read elsewhere that these bonds were actually required as collateral, but I don't have the source handy so can't vouch for it). What bothers me most about their analysis is that while mentioning optimal currency area theory, they don't go into it in any depth. A key point, to which they give some but perhaps not enough attention, is the imbalance in terms of trade caused by areas with very different cost structures, such as Portugal, Spain, and even Italy, sharing a currency with Germany. They seem to think that "structural reforms", especially of the labor market, will fix that. In fact, in their reading (and also in that of many opponents of Euro area austerity and ECB's relatively tight monetary policies) a main goal of the ECB is to get such structural---and political, if necessary---change in some of the Euro area countries. I think they underestimate the difficult of getting this done---especially if it goes hand in hand with "austerity". They do recognize the need for growth:
Even the most successful financial engineering in the euro
area will ultimately fail, however, if the debtor countries,
and indeed the region as a whole, are unable to restore at
least modest economic growth in the fairly near future. This
requires at least three major steps:
* The borrowing countries must adopt convincing progrowth
structural reforms, especially in their labor
markets, as well as budgetary austerity.
* The strong economies in the northern core of Europe,
especially Germany, must terminate their own fiscal
consolidations for a while and adopt new expansionary
measures, i.e., they should buy more Italian and Greek
goods and services rather than debt instruments.
* The ECB must promptly reduce its policy interest rate
by at least another 50 basis points and buy sufficient
amounts of periphery bonds through the SMP to help
push their interest rates down to sustainable levels.
Do they really have confidence that to save the Euro Germany will loosen its fiscal policy enough to create a significant boost to the European "periphery" from trade, and that the ECB will loosen monetary policy enough to offset their prescribed austerity in the periphery, and boost Euro periphery growth (from trade and from credit availability)? I guess they are saying that they do. There's a lot of room for political turmoil here if it doesn't happen this way, and what current heads of state and Euro institution leaders think may in that case not end up being the determining factor. Also, EU leaders will is one thing, but many actors' notions of "expansionary austerity" seem to be rooted in a misunderstanding of economic dynamics. ECB president Draghi's background is somewhat reassuring here, but he's not the only actor, and even he seems to be playing off a willingness to do macro stabilization against other goals of political and economic reform.
Regarding the budget rules that are part of the new fiscal institution building Bergsten and Kierkegaard are so partial to, conservative (but reality-based) economist Martin Feldstein on European austerity is worried: How to Create a Depression contains as good a description as any of the Keynesian (or neo-Keynesian, if you like, in the sense of post-WWII US macroeconomics) notion of automatic fiscal stabilization.
Feldstein does not succumb to the temptation that attracts many right-wing hacks (he, of course, is not a hack), and even many proudly centrist folk (including hacks) who are not terribly well informed on economics, to take all Eurozone deficits as evidence of fiscal irresponsiblility:
Italy, Spain, and France all have deficits that exceed 3% of GDP. But these are not structural deficits, and financial markets would be better informed and reassured if the ECB indicated the size of the real structural deficits and showed that they are now declining. For investors, that is the essential feature of fiscal solvency.
An important part of the deficit agreement in December is that member states may run cyclical deficits that exceed 0.5% of GDP – an important tool for offsetting declines in demand. And it is unclear whether the penalties for total deficits that exceed 3% of GDP would be painful enough for countries to sacrifice greater countercyclical fiscal stimulus.
The most frightening recent development is a formal complaint by the European Central Bank that the proposed rules are not tough enough. Jorg Asmussen, a key member of the ECB’s executive board, wrote to the negotiators that countries should be allowed to exceed the 0.5%-of-GDP limit for deficits only in times of “natural catastrophes and serious emergency situations” outside the control of governments.
Perhaps this is just part of the game of chicken. Certainly it's heartening that the December ECB agreeement does explicitly distinguish between structural and cyclical sources of deficits, and foresee a role for automatic fiscal stabilization through cyclical deficits. But one worries: to what extent does Asmussen represent a broader consensus at the ECB, and what will they do---how long will they drag things out, how tight will they keep money---to try to get their way. And what would be the consequences if they do? Is the economic story of the Eurozone for the next decade or two going to be a continuing game of chicken, accompanied by stagnation? Will this be politically tenable?