My favourite contemporary economist is UCL’s Professor Wendy Carlin. She was my tutor at UCL, and led my second year macroeconomics course, and a third year course on European institutions. Her patient, dispassionate analysis is worth so much more than all that shoot-from-the-hip banging on by celebrity economists, Nobel Laureates and all. It was her analysis, well before the current crisis broke, that demonstrated to me that the last government’s economic “miracle” was unsustainable (the combination of an appreciating real exchange rate and a trade deficit being the giveaways). She also helped me understand the Eurozone, and pointed out the trouble ahead, again well before it happened, arising from diverging real exchange rates within the currency bloc – in other words Germany was becoming more competitive while Italy, Spain and others were becoming less so.
So I was delighted to read her summary of the Eurozone crisis – 10 questions about the Eurozone crisis and whether it can be solved. The is a wonderfully clear summary of the whole situation, written in early September. Her central point is that the zone’s banking system is at the heart of the crisis, and tackling the banks will the heart of any solution. European politicians have been trying to avoid this, no doubt because it shows that Northern European countries have played an important role in creating the crisis. However, not least thanks to the new IMF chief Christine Lagarde, this is changing.
Of course Professor Carlin cannot point to an easy escape. She points to two alternatives paths, other than the breakup of the zone:
Scenario #1 – a more decisive approach based on current policy (bailouts)
- the existing bailout schemes to be successful and to be seen to be working in the next year
- to keep Italy out of the bailout regime
- to develop a replacement for the high moral hazard regime for banks and for governments but to do this in a way that does not undermine the bailout regime in the meantime.
Scenario #2 – large-scale restructuring of bank and government debts (defaults)
- to move decisively now to end the high moral hazard regime by accepting that default on bank and government bonds on a much larger scale than envisaged in Scenario #1 is necessary
- to engage in restructuring sovereign debt and bank debt by, for example, forcing bond-holders to swap existing short-term bonds for long-term