The Future of the Euro and the Role of Central Banks

February 22, 2012
By Marco Magnani, M-RCBG senior fellow and Tania Das, joint MPA/MBA candidate

In many ways, things in Europe look better than they did just a month or two ago. The European Central Bank cannot buy sovereign debt but is providing banks with almost unlimited cash, which can be used to buy governments’ bonds and indirectly lowers the tension on sovereign debt. Also, the crisis is forcing several countries to undertake much needed economic reforms, which should have positive consequences.

Guest speaker Lorenzo Bini Smaghi, former executive board member of the European Central Bank and current visiting scholar at Harvard’s Weatherhead Center for International Studies suggests there are two major lessons learned from the crisis so far, the first one is that “financial contagion operates in unexpected ways, especially after a major shock,” said Bini Smaghi. Second, “central banks, as policymakers, cannot opt out of their own responsibility for making decisions.” Postponing decisions typically leads to worse outcomes. Bini Smaghi discussed these ideas with Harvard Kennedy School students at a seminar held on Wednesday, February 15 at the Mossavar-Rahmani Center for Business and Government (M-RCBG).

Bini Smaghi believes that in the last several years, the European monetary union has changed in ways that could not have been foreseen. Today there is a financial safety net – the European Financial Stability Facility (EFSF), to be replaced by the European Stability Mechanism – that has reinforced governance and a stronger fiscal discipline. He asserts that these changes were necessary because the monetary union was built on the naive assumption that there would be no crises.

Additionally, the speaker talked about how the economic and financial crisis exposed a series of institutional problems related to the roles and responsibilities of various authorities at national and supranational level - the confusion between roles risked generating moral hazard and undermining their credibility. Bini Smaghi emphasized how in Europe business and Government have cooperated fairly well during the crisis while what in his opinion has failed to work is the relationship with the financial sector.

picture of John Haigh, Lorenzo Bini Smaghi and Marco Magnani

(From L to R) John Haigh, executive dean; Lorenzo Bini Smaghi,former executive board member of the European Central Bank and Marco Magnani, Center for Business and Government senior fellow.

“Financial contagion operates in unexpected ways, especially after a major shock,” said Bini Smaghi.


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