Is Europe Reforming? At the Bellwether Economist Conference

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On 15th May, the Bellwether Economist Conference (see program) posed the broader question “Who will fill the funding gap?” and the narrower but crucial question “Is Europe Reforming?” In this post the reader can find/hear my contribution in lieu of an answer to the second question, as well as to questions on how the ECB should practise quantitative easing, how the Greek debt crisis ought to have been handled etc.



  • Winfried Bischoff, Chairman, Financial Reporting Council
  • Yanis Varoufakis, Professor of Economic Theory, University of Athens & University of Texas at Austin, Author, The Global Minotaur
  • Turalay Kenç, Deputy Governor and Member of the Monetary Policy Committee, Turkish Central Bank  

In my introduction, I began by saying that there is a dominant perception worldwide that, while frustratingly slowly, Europe is moving in the right direction. In contrast to this view, my remarks revolved around the following counter-point: The institutional reforms enacted by the Eurozone, in response to the Euro Crisis, are pushing Europe, not in the right direction too slowly but, in the wrong direction too swiftly! I gave four examples of swift moves in the wrong direction:

1. The so-called Banking Union

Europe proclaimed a Banking Union in name to deny it in practice. Instead of ending the mutual reliance between fragile states and fragile banks, the so-called Banking Union ended up strengthening it. Even worse, by giving the ECB the role of sole supervisor of the Eurozone’s main banks, in the absence of a common backstop and deposit insurance scheme, the so-called Banking Union compromised the ECB. It put its auditors in an impossible dilemma, when they find out that some Italian or Greek bank’s asset book is dodgy between: (i) triggering off another spate of financial and public debt panic (by revealing the truth about the bank’s situation) and (ii) remaining silent and in breach of its supervisory remit.

Just as a little knowledge may be a terrible thing, similarly a half-baked banking union may also prove disastrous – and worse than not having it!

2. The European (In)Stability Mechanism

As soon as Europe created the European Stability Mechanism (ESM), for the purposes of giving out bailout loans to financially stressed member-states, it was (essentially) moth-balled. Indeed, it is a fair claim that its creators (Berlin, Paris etc.) would very much like to leave it perpetually unused. With good reason too. For deep inside the bonds that the ESM issues in order to fund its bailout loans, lies buried the domino dynamic: as the marginally insolvent member-state crosses from being a guarantor of these loans to being a recipient, the next marginal member-state’s liabilities rise and it too crosses the line into insolvency. The ESM, in this sense, is, without exaggeration, a European Instability Mechanism. No wonder Berlin had to accept Mr Draghi’s, adn the ECB’s, OMT intervention as a substitute of ESM loans to Italy and Spain.

3. OMT

The Outright Monetary Transactions program of the ECB is the great success story of the EU’s crisis fighting efforts of the past four years. Alas, it is a phantom program based on an incredible threat. What is the threat? It is that bond dealers betting that Italy’s bond yields would exceed a certain level will lose money as the ECB is intent on printing as much money as it is necessary to purchase as many Italian bonds as are needed in order to push Italian yields below the target level. Why was this threat non-credible? Because the only way Berlin would approve of the OMT announcement was if it came with the sort of conditionality that would cause the government in Rome to collapse. Why did it work? Because bond dealers believed that the ECB was ready to step in and that the conditionality was a fig leaf in order to keep Berlin on side. How did it work? On the basis of an equilibrium of belief that went as follows: Bond dealers thought that enough bond dealers would believe that enough bond dealers would believe that … the ECB would step in to buy bonds regardless of whether Rome signed on the dotted line of a Greek-style Memorandum of Understanding. It worked because the OMT program was never tested.

Hats off to Mr Draghi for making this work. Having said this, does anyone consider OMT to be a sustainable, worth, long-term institution? Can a new institutional arrangement stand the test of time when it is based on a (logically) non-credible threat? Would it have ever worked, to suppress as much as it did, the Eurozone’s yields if it were not for the deflationary expectations that supported the low nominal but high real interest rates of the Periphery’s bonds?

4. Fiscal Pact

Mrs Merkel demanded that member-states accept constitutional amendments (or the equivalent, depending on member-states’ legal framework) to take structural budget deficits out of the national governments’ discretion and, essentially, to make them illegal. So what? Spain and Ireland not only would have been happy to agree to these rules prior to 2008 but, indeed, they would have been in compliance with them. And then, once the credit crunch hit, their budget would have gone, as they did, in scarlet red territory. No constitution, no treaty, no covenant can prevent insolvency, regardless of Will, Intent or Aspiration. This ‘reform’ was no more than an act of faith that is bound to crash on the shoals of reality when the crisis hits.


In my concluding remarks, I argued that a monetary union too fragmented to absorb a grand shock (the 2008 credit crunch) has responded to it by institutionalising its… fragmentation. Rumours that the Euro Crisis is over are instrumental in perpetuating the crisis by reinforcing official Europe’s Grand Denial that there is something profoundly wrong with the Eurozone’s architecture. The Grand Denial,n in turn, feeds into institutional ‘reforms’ that push Europe in the wrong direction fast. The more the Grand Denial is reinforced by the rumour that the Euro Crisis is fading, the faster and more surely Europe will continue to deform, as opposed to reform.

Here is an amateurish recording (which is quite audible if one uses a headset) of my main presentation. It comes after some remarks by Sir Winfried:

Here the panel is discussing the question: “Have we saved the euro? How can we promote growth?”

What should we have done to cope with the debt crisis, as opposed to what Europe actually did?

Finally, here is a recording of the discussion that followed with members of the audience on issues like “What is our view on QE? What is the state of the Periphery?” – apologies for the nearly inaudible questions from the audience

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