Podcast: "The next crisis could be bigger than the last one"
John Cochrane, Luis Garicano and Klaus Masuch on how to toughen up the euro
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The euro was never expected to have an easy life. That’s why its architects built in safeguards against budgetary indiscipline, ensured flexibility to withstand external shocks, and even (unnoticed to many at the time) empowered the European Central Bank to buy and hold government debt.
What their mid-1990s imagination failed to anticipate was a solvency crisis that could have ended the euro’s life in its early teens, five government bailouts, seven years of stubbornly low inflation followed by a once-in-a-century pandemic and land war, and a consequent unleashing of public debt and inflation.
In 2010-12 and even in 2020-22, the euro area wasn’t politically or institutionally ready. Policy was made on the fly. The need for speed forced governments to drop long-standing principles then re-adopt them when they felt the pressure was off, leading to the kind of policy inconsistency we see today in Washington but without the “Truths”. A Greek debt restructuring was vetoed then allowed. Some bank bondholders were wiped out, others left whole at taxpayers’ expense, and - on one occasion - uninsured depositors shared the pain.
For all these policy improvisations, the euro survived because thanks to the ECB and its readiness to step in at crucial moments as the system’s underwriter. Sometimes, it got away with just words - “whatever it takes”, outright monetary transactions (OMT), and a transmission protection instrument (TPI), for example - but these only worked because of the ECB’s proven willingness to do whatever it took. At its peak in 2022, the ECB had taken assets worth more than half the euro area’s output onto its balance sheet.
In Crisis Cycle: Challenges, Evolution, and Future of the Euro, published today by Princeton University Press, three renowned economists - John Cochrane, Luis Garicano, and Klaus Masuch - tell the euro’s unlikely life story and call for an end to this dangerous improv. “We just had a warm-up in 2020,” Cochrane told me in a New Books Network interview with all three writers. “If the next time … let's say China invades Taiwan and there's a global financial crisis that will follow that and a global recession, and our governments repeat what they did in 2020 on steroids: throwing money around, who is going to lend 10 trillion new euros given that the last time they lent the governments a lot of money to finance a crisis, they got an instant 20 percent-ish haircut from cumulative inflation? Bond markets are nervous. They're nervous about the US. They're nervous about Europe”.
As Trumpism raises questions about the continued global safe-haven status of the dollar, some European policymakers - including ECB President Christine Lagarde - have ambitions for the euro. They can start, says Cochrane, by making swift changes to ensure “that the euro shouldn't implode in the next crisis – whatever crisis it is that brings the dollar down. The great global sovereign debt crisis … The next crisis could be bigger than the last one and that's when the euro will have its challenge … Your first task is to set things up to survive that crisis”.
John Cochrane is professor of economics at Stanford University. He is best-known for his work on asset prices and the fiscal theory of the price level, as well as writing the Grumpy Economist Substack and and co-fronting the Goodfellows podcast. Luis Garicano is a professor at the London School of Economics, the former economic guru for Spain’s Ciudadanos party and vice-chair of the Renew group in the European Parliament from 2019-22. He also has a compelling Substack: Silicon Continent. Until his retirement this year, Klaus Masuch was a senior official at the ECB for its entire history. Most recently, he was a principal adviser in the economics directorate but, most relevantly to the book’s themes, he was the ECB’s delegate to the Troika – the three-institution club (with the European Commission and the International Monetary Fund) that negotiated aid and adjustment programmes for Greece and Ireland.
To find out the books each of them recommended for my 105-author Writers’ Writers tip sheet, click here.