At any wedding celebration, the audience usually expects a loud and firm “Yes”. In European politics these days, Germany’s partners expect a loud and firm “Yes” to whatever proposal for saving the euro is on the media agenda. Yet, Germany’s answer has often been an initial “No,” yielding finally to a whispered “Yes, but….” Please, don’t let me be misunderstood: Germany’s “Yes” to the euro remains firm and has already brought about a massive German policy shift on the architecture of the euro area.

In early 2010, prompted by the Greek revelation of budget problems, the focus of attention shifted from real estate and the global cycle to public debt issues in the US and a couple of member states of the euro area. The collective policy response to the ensuing plight of severe sovereign debt funding problems in Greece, Ireland, and Portugal − and more modest versions of the same sickness in other member states − was quick and straightforward in addressing flaring crises over the last 16 months, yet slow and cumbersome in establishing a rock-solid longer-term defense. However, these have been the travails of transition.

Now, we are getting close to a sustainable solution. Huge changes to EMU are being brought about. In a few weeks, a fully refurbished EMU will be vastly better equipped to cope with such contingencies. During the transition, the EU invented a balance-of-payments and public re-financing scheme for members of EMU and a new institution, the European Financial Stability Facility, which taps capital markets. The EFSF will be renamed the European Stability Mechanism in 2013 but will keep its essential functions. The EU embraced and entangled the IMF in the resolution of public debt crises in euro-area member states (Greece, Ireland, and Portugal). The European Central Bank buys national government bonds, and national central banks of the Eurosystem engage in emergency lending to their banking systems. In July 2011, the Council also decided on initial debt restructuring in Greece of some 20% as part of a larger adjustment and financing program. In addition, a policy package strengthening fiscal and macroeconomic surveillance will soon be adopted.

However, neither the European institutions nor the national governments have been successful in convincing financial markets of the adequacy of the policy response so far. This is why the perception in the EU shifted from a mental framework of recovery, after a huge recession in early 2010, to the framework of a “lost decade” if things go well or a “lousy decade” if things do not go well in early 2011. Yet, there is absolutely nothing deterministic about it. The fate of Europe and of EMU may, and most likely will, be shaped by better macroeconomic policies in both debtor and creditor countries, and by structural reforms strengthening growth. Large policy spaces exist even in periods of fiscal adjustment in the vast majority of EU member states. There are no more than a handful of cases in which additional policy levers have to be applied, such as supporting growth from the EU and international level, restructuring public debt, or other elements. The EU policy response to these crises has yet to be fully developed.

Now, some media commentators doubt the political commitment of the German parliament, and of the public at large, to the rescue operation for the euro. This partly stems from the fact that financial markets had not calmed down by the July 21st decisions at the European Council. The EFSF will be authorized to extend precautionary credit lines to countries in good shape, to intervene in secondary bond markets of euro-area countries in an EU/IMF program, and to supply capital to banks. Yet fears of Italy, Spain, and even France facing a strong deterioration in funding conditions did not abate, thus prompting the ECB to intervene. All these difficulties, however, did not cause a wavering of Germany’s stance towards a steady resolution of the issues. Again, clarity is important. This is not about a final jump towards deeper integration, joint debt issuance, and collective euro-area decision-making on national budgets starting in 2012. Rather, the current thrust of politics is more about firmly establishing a move towards comprehensive policy reform in Europe and a gradual return to the first principles of EMU, such as national fiscal responsibility.

There is no doubt that the German Bundestag will vote “Yes” on recent reforms. There is, however, some serious debate about how exactly parliament will be involved in decision-making. On September 1, the governing conservatives decided that the German parliament will have to consent to the use of EFSF funds for country programs, or changes in them, and market interventions. There is broad support within the ruling coalition of conservatives and liberals for such changes, as well as from the Social Democrats and the Greens. Mounting an effective defense may even call for stronger measures in the future, and may also involve sharing some fiscal pain down the road if guarantees are drawn. Perhaps equipping the EFSF or its successor, the European Stability Mechanism, with additional powers, either more funds or a bank license, may become necessary over time. And again, this can be done to some extent. However, there are both economic and political limits. It will not become politically palatable for Germany to underwrite all euro-area debt, as it would neither be credible nor politically acceptable, since the required amount of conditionality or joint decision-making at the supranational level is simply too large at present.

National consolidation and reform in euro-area countries will remain of paramount importance, though. These policies have to be tailored to national circumstances. There is nobody in Berlin, or for that matter in Brussels, prescribing the specific policy packages supportive of growth for each capital, and there will be nobody doing so in future. The “Euro-Plus-Pact” of voluntary national reform commitments is much more a demonstration of de facto policy space for reform in every member state than it is an overly tight swimming suit. Clearly, there is also scope for better economic management in Germany itself. The real difficulty with Europe over the last 16 months was not so much the substance of the solution now almost within reach, but the difficulty of writing the songbook and then singing the songs of resolution.


Klaus Deutsch is a AICGS Non-Resident Fellow and works for Deutsche Bank Research.