M-RCBG Associate Working Paper No. 69
The Financial Education of the Eurozone
The European Project looks in trouble once again. Mounting political extremism, feeble growth and the loss of its second largest economy shape a convincing case that the integration of Europe’s political and economic institutions has failed to deliver. The common currency, it appears, has created more mutual resentment among its members than mutual solidarity, and the calls for more exits has led many to conclude it was all a terrible mistake. And yet, it survives and in many ways prospers. The reinforcement of euro area institutions following a sudden stop in global financial flows suggests a surprising resilience. Indeed, the euro as a store of value did not suffer directly from the crisis. And for all the gnashing of teeth, euro area governments were forced to double down on their commitments to one another under the skeptical watch of global financial markets. Even in the face of certain voter rebellion, they opted for measures for integration rather than separation or dissolution. For a project that is perennially on the verge of collapse, it is worth re-examining how these leaders committed significant sums of taxpayer resources and agreed to an unprecedented sharing of sovereignty.
This paper argues that the resilience comes from the deep financial integration of the currency union that created both stronger links of interdependence among its members as well as greater flexibility to absorb shocks. On the one hand, the financial market turmoil made it painfully clear to European leaders that investors viewed Europe as more or less a single borrower notwithstanding a treaty that said otherwise. On the other hand, this integration, especially through the banking system, provided mechanisms to reallocate resources throughout the currency union in order to absorb the asymmetric shocks through liquidity injections, market purchases and the euro area payments system. Like the large noisy family they claim to be, European leaders found themselves stuck with the costs of their relatives’ mistakes, yet able to reallocate emergency resources under the table even as they sought to set up formal new rules to provide support and enforce discipline. If there is an optimistic case to be made for the euro area, it may be that strengthening its Banking Union can proceed even as the political climate makes structural reforms, fiscal pooling or labor mobility more difficult. Moreover, financial market forces may encourage progress on banking supervision and stability in spite of lingering voter doubts. Arguably, the European political calendar over the next year will put these ideas to their most severe test yet in key national elections. Until now, however, the "Financial Education of the Eurozone" is both the story of global markets forcing political leaders to take unpalatable steps to reinforce their monetary union, and the dawning realization that this very interdependence through markets and banks will likely drive further integration. Steady progress on the technical steps required to enshrine Banking Union and capital market integration may not be sufficient to secure the euro’s long-term survival, but they are necessary and realistic next steps amid the current political turmoil.