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A Tale of Two Trilemmas
In order to understand why EMU happened, we often turn to the familiar Mundell-Fleming monetary policy trilemma. Given intra-European capital mobility, the decision by a subset of EC members to move to EMU was a logical, if radical response to the challenges posed by this trilemma. However, the institutional framework of EMU is seriously flawed. For decades economists have argued that fiscal union was a desirable, and perhaps indispensable, complement to EMU. What we now know is that a common eurozone framework for regulating financial institutions, and dealing with the consequences of their failure, is equally important. We have a monetary union with neither of these complementary institutions, and it is clear that this architecture is not fit for purpose. How did we end up here, and what happens now?


Superimposed upon these long-run political cleavages are the effects of the global crisis of 2008-9, and the present banking crisis. In principle, the global financial crisis could have led people to view the EU as a port in the storm, and there is an element of this in the Irish referendum approving the Lisbon Treaty in 2009. On balance, however, Eurobarometer surveys indicate that attitudes towards the EU have become more negative during the crisis, while there has been a fairly dramatic deterioration in trust in the institutions of the Union. The interaction between a sharp economic crisis in several countries, and underlying class-based or national hostility to EMU, could turn out to be a potent one. Even more serious could be the mishandling of the banking cum debt crisis. The decision of the ECB to veto the new Irish government's desire to impose burden sharing on private bank bondholders is extraordinary, and provides Irish eurosceptics with an extreme example of the democratic deficit in action. Meanwhile, taxpayers in Finland and elsewhere are revolting against the notion that they should bail out their profligate partners - recognising that this is a European banking crisis that needs a European solution might help change perceptions. So would recognising that an end to regulatory competition in the financial sector would be a more logical concession to be sought from the Irish, in return for cutting interest rates, than an increase in their corporate tax rate.

Whether EMU can survive in the long run if the status quo persists is an open question.  Governments have tended to muddle between the stark trade-offs implied by the political trilemmas, but this crisis may force them to confront those trade-offs head-on. What happens then is anyone's guess.

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Wed Apr 27th, 2011 at 04:12:55 AM EST

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