Destarac final paper by SMU Engaged Learning

Causes and Possible Solutions to the Eurozone Crisis

Jean Paul Destarac

Economics 4390: Independent Study 1

Advisor: Dr. Osang 1 This independent study is part of a larger research project for which Jean Paul Destarac received the Engaged Learning Grant, Hamilton Fellowship, and Richter Fellowship.

Table of Contents 1. INTRODUCTION .................................................................................................................................. 5 1.1 BACKGROUND ..................................................................................................................................................... 5 1.2 DEFINITION OF A MONETARY UNION .......................................................................................................... 6 1.3 OPTIMAL CURRENCY AREA .......................................................................................................................... 7 1.4 COSTS AND BENEFITS OF A MONETARY UNION ......................................................................................... 8 2. IS THE EUROZONE AN OPTIMAL CURRENCY AREA? ........................................................... 9 2.1 LABOR MOBILITY ................................................................................................................................................ 9 2.2 CAPITAL MOBILITY ......................................................................................................................................... 10 2.3 FISCAL TRANSFERS ......................................................................................................................................... 11 2.4 SYMMETRY OF IDIOSYNCRATIC SHOCKS ...................................................................................................... 11 2.5 BUSINESS CYCLE INTEGRATION .................................................................................................................... 11 3. MONETARY POLICY IN THE EMU ............................................................................................... 12 3.1 CONVERGENCE CRITERIA OF THE EUROPEAN MONETARY UNION ........................................................ 12 3.1.1 Price Developments ................................................................................................................................ 12 3.1.2 Exchange Rate Developments ........................................................................................................... 13 3.1.3 Long-‐term Interest Rate Developments ........................................................................................ 13 3.1.4 Fiscal Developments .............................................................................................................................. 13 3.2 EUROPEAN CENTRAL BANK ...................................................................................................................... 14 5. REASONS FOR THE CRISIS ............................................................................................................ 20 5.1 EXCEPTIONS OF STANDARDS FOR NEW MEMBERS ................................................................................... 20 5.1.1 Greece ........................................................................................................................................................... 20 5.1.2 Italy ............................................................................................................................................................... 21 5.1.3 Belgium ....................................................................................................................................................... 22 5.1.4 Gross Government Debt ........................................................................................................................ 22 5.1.5 Gross Budget Deficit .............................................................................................................................. 23 5.1.6 Average Yearly Inflation ...................................................................................................................... 23 5.2 DEALING WITH NON-‐ADHERENCE TO STANDARDS BY EXISTING MEMBERS ........................................ 23 5.2.1 Greece ........................................................................................................................................................... 24 5.2.2 Italy ............................................................................................................................................................... 24 5.2.3 Belgium ....................................................................................................................................................... 25 5.2.4 Portugal ...................................................................................................................................................... 25 5.2.5 Ireland ......................................................................................................................................................... 25 5.2.6 Spain ............................................................................................................................................................. 26 5.2.7 France and Germany ............................................................................................................................. 26 5.3 VIOLATIONS OF OPTIMAL CURRENCY RULES ............................................................................................. 27 5.3.1 Labor Mobility .......................................................................................................................................... 27 5.3.2 Capital Mobility ....................................................................................................................................... 28 5.3.3 Fiscal Transfers ........................................................................................................................................ 28 5.3.4 Symmetry of Idiosyncratic Shocks ................................................................................................... 29 5.3.5 Business Cycle Integration .................................................................................................................. 29 5.4 CURRENT ACCOUNT IMBALANCES ............................................................................................................... 30 5.5 DECISION-‐MAKING WITHIN THE EU ........................................................................................................... 32 5.5.1 Lags in Decision-‐Making ...................................................................................................................... 32 5.5.2 Structure of Decision-‐Making ............................................................................................................ 32 5.6 STRUCTURAL PROBLEMS IN THE EU ........................................................................................................... 33 6. POSSIBLE SOLUTIONS ................................................................................................................... 33

3 6.1 ECB BASED FINANCIAL ASSISTANCE .......................................................................................................... 34 6.1.1 European Financial Stability Facility (EFSF) ............................................................................. 34 6.1.2 European Financial Stabilization Mechanism (EFSM) .......................................................... 34 6.1.3 European Stability Mechanism (ESM) ........................................................................................... 35 6.1.4 ECB Backed European Bonds ............................................................................................................ 35 6.1.5 Evaluations ................................................................................................................................................ 36 6.2 BANKING UNION .............................................................................................................................................. 37 6.2.1 Placing Eurozone Banks under the Supervision of the ECB ................................................. 37 6.2.2 Creation of a Bank Resolution Scheme .......................................................................................... 38 6.2.3 Common Deposit Scheme .................................................................................................................... 39 6.2.4 Evaluations ................................................................................................................................................ 39 6.3 EXCLUDING WEAK NATIONS FROM THE EUROZONE ............................................................................... 40 6.3.1 The Case of Greece and Cyprus ......................................................................................................... 40 6.3.2 Short-‐Run Impact ................................................................................................................................... 41 6.3.3 Long-‐Run Impact .................................................................................................................................... 42 6.3.4 Evaluations ................................................................................................................................................ 42 6.4 COMMON FISCAL AUTHORITY ....................................................................................................................... 42 6.4.1 The Concept of a Fiscal European Union ...................................................................................... 42 6.4.2 Evaluations ................................................................................................................................................ 43

7. CONCLUSIONS .................................................................................................................................. 44 8. REFERENCES ..................................................................................................................................... 46 8.1 LITERATURE WITHOUT IDENTIFIED AUTHOR ........................................................................................... 46 8.2 LITERATURE WITH IDENTIFIED AUTHOR .................................................................................................. 48 8.3 LIST OF INTERVIEWS ...................................................................................................................................... 54 9. APPENDIX .......................................................................................................................................... 55 9.1 INTERVIEWS: ACADEMIA-‐ECONOMICS ........................................................................................................ 55 9.1.1 Dr. Carsten Brzeski ................................................................................................................................. 55 9.1.2 Dr. Rolf Campos ....................................................................................................................................... 60 9.1.3 Dr. Robert Gassler ................................................................................................................................... 68 9.1.4 Dr. Scott Gassler 2 ................................................................................................................................... 73 9.1.5 Dr. Jean-‐Victor Louise ........................................................................................................................... 77 9.1.6 Dr. Bert Mosselmans .............................................................................................................................. 83 9.2 INTERVIEWS: ACADEMIA-‐POLITICAL SCIENCE .......................................................................................... 87 9.2.1 Dr. Amandine Crespy ............................................................................................................................. 87 9.2.2 Dr. Michel Huysseune ............................................................................................................................ 93 9.3 INTERVIEWS: EUROPEAN UNION OFFICIALS ............................................................................................. 97 9.3.1 PB ................................................................................................................................................................... 97 9.3.2 HG ............................................................................................................................................................... 100 9.3.3 Dr. PW ....................................................................................................................................................... 105 9.3.4 Dr. GS ......................................................................................................................................................... 108 9.4 INTERVIEWS: THIRD PARTY ........................................................................................................................ 111 9.4.1 Jean Gabriel Arqueros ........................................................................................................................ 111 9.4.2 Dr. Zsolt Darvas .................................................................................................................................... 116 9.4.3 Mexican Ministry of Economics’ Mission to the European Union ................................... 123 9.4.4 Dr. Fabian Zuleeg ................................................................................................................................. 126 9.5 GRAPHS ........................................................................................................................................................... 131 Graph 1: Greek Debt compared to Eurozone Average .................................................................... 131 Graph 2: Current Account Balances – 2010 ........................................................................................ 132

4 Graph 3: Annual GDP growth – percentage change from previous year ............................... 133 Graph 4: Unemployment Rate ................................................................................................................... 134 Graph 5: Government annual surplus or deficit ................................................................................ 135 Graph 6: Government debt as a proportion of GDP ......................................................................... 136 Graph 7: European current account balances (% of GDP) ........................................................... 137 Graph 8: European current account balances (% of GDP) ........................................................... 138 Graph 9: Current Account Balances under EMU (% of GDP) ....................................................... 139 Graph 10: Current Account Balances under EMU (% of GDP) .................................................... 140 Graph 11: Current Account Balances under EMU (% of GDP) .................................................... 141 Graph 12: Real exchange rates ................................................................................................................. 142 Graph 13: Real exchange rates ................................................................................................................. 143 Graph 14: Real exchange rates ................................................................................................................. 144 Graph 15: Real exchange rates ................................................................................................................. 145 Graph 16: Gross Government debt two years prior to entry ........................................................ 146 Graph 17: Government budget surplus two years prior to entry ............................................... 147 Graph 18: Average yearly inflation in Eurozone countries, 1999-‐2007 ................................. 148 Graph 19: General government consolidated gross debt .............................................................. 149 Graph 20: Budget Deficit and Public Debt to GDP 2012 ................................................................ 150 Graph 21: Total Cost of ECB Bailouts ..................................................................................................... 151 9.6 MAPS ............................................................................................................................................................... 152 9.6.1: Map of EU ............................................................................................................................................... 152 9.6.2 Map of the Eurozone as of 2013 .................................................................................................... 153

1. Introduction2 1.1 Background On January 1st 19993, the exchange rates of eleven European nations4 became fixed to each other, a decision which has since escalated to the creation of the euro. These decisions have not been spontaneous but have been slowly coming together for decades. It all began as an idea of Jean Monnet,5 and slowly formed the European Union seen today. In 1914, Europe was the center of economic power with many global empires and tremendous cultural influence. Just a few decades later, in 1945, much of Europe lay in shambles with its economic and cultural power greatly reduced. At that time, America began to dictate policies in Western Europe and Germany was divided between East and West. The two World Wars killed tens of millions of Europeans. Europeans were concerned because of the high level of death and destruction that occurred and wanted to think of something that would prevent this from ever happening again. Monnet wrote a plan to get countries that had been suspicious of each other for hundreds of years to work together. It all began as a trade union, which was established in the Treaty of Paris of 19516 and termed the European Coal and Steel Community. He thought of removing tariffs for the coal and steel industry between a few countries. From this was born the Treaty of Rome of 19577, where six countries formed a free trade area: France, Italy, Austria, Germany, Belgium, and Luxembourg. France and Germany dominated this European experience and to this day are the leading voices. On November 1st, 1993, the 2 The concept of this paper was created on Jean Paul’s first trip to Europe where he was able to observe some of the structures of the European Union and learn more about the European project. The idea to analyze the crisis using his studies in economics and sociology was guided by Dr. Osang. This paper was developed through preliminary interviews in Brussels in the summer of 2012 and followed by a literature review in the fall of 2012. During winter break of 2012, Jean Paul travelled to Brussels to conduct more interviews. The arguments and explanations exposed in this paper were developed in the spring months of 2013. 3 “The euro was launched on 1 January 1999, when it became the currency of more than 300 million people in Europe.”-European Central Bank Eurosystem Introduction: Use of the euro. http://www.ecb.int/euro/intro/html/index.en.html 4 Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland. Countries taken from the European Commission’s site on Economic and Financial Affairs. 5 Jean Monnet was a French economist and public official who lived from 1888 to 1979. He is considered as the father of the European Union and one of the main actors in its creation. He served as president of the European Coal and Steel Community from 1952-1955. 6 Treaty establishing the European Coal and steel Community. Europa: Summaries of EU legislation 7 Treaty establishing the European Economic Community. Europa: Summaries of EU legislation

Treaty of Maastricht8 entered into existence with the goal of further unifying Europe through economic integration by establishing the European Monetary Union, which involved a single currency for the Eurozone. Through all of these changes, enlargements, and treaties it is difficult to determine what the European Union really is and what it wants to be. Does it want to be a political power, economic power, cultural power, or all of the above? What we know is that today, the European Union is a supranatural organization encompassing 27 nations9. These nations are integrated politically, economically, culturally and possibly militaristically as well10. The EU is also a multilateral union11. Multilateralism refers to the fact that the states cooperate but develop certain common values, norms, and general principles of conduct12. There has been some criticism for the expansion of the EMU. Some people have argued that there have been many structural and decision-making problems in the Eurozone from the beginning. However the first years of the Eurozone did not show many negative effects. Though, after being put under the stress of a debt crisis, more politicians, economists, and policymakers are noticing large problems in the structural organization of the Euro. The current recession and sovereign debt crises affecting many countries in Europe are leaving the world with their eyes on Europe questioning what policymakers will do. It is more evident that some long-lasting changes must be made to perfect the Eurozone project.

1.2

Definition of a monetary union

A currency union, or monetary union is where one or more countries share a common currency with or without other unifying factors. The 1970 Werner Report states, “A monetary union implies inside its boundaries the total and irreversible convertibility of currencies, the elimination of margins of fluctuations in exchange rates, the irrevocable fixing of parity rates, and the complete liberation of movements of capital” (The Werner Report of 1970). Considering that analysis, a currency union is similar to several countries running a fixed exchange rate regime with each other. All the nations have realized that there would be greater efficiency benefits to unite under one currency than if each kept 8 Treaty on European Union-Maastricht Treaty. Europa: Summaries of EU legislation. 9 The European Union as an Integrative Power: Assessing the EU’s ‘Effective Multilateralism’ towards NATO and the United Nations. 10 The European Union as an Integrative Power: Assessing the EU’s ‘Effective Multilateralism’ towards NATO and the United Nations. 11 The European Union as an Integrative Power: Assessing the EU’s ‘Effective Multilateralism’ towards NATO and the United Nations. 12 The European Union as an Integrative Power: Assessing the EU’s ‘Effective Multilateralism’ towards NATO and the United Nations.

its old currency. One can also look to Masson and Taylor, which state that a currency union is “an area throughout which a single currency is accepted as a primary medium of exchange” (Masson and Taylor 1992). In 1961, Robert Mundell published The Theory of Optimal Currency Areas, in which he noted the idea of requirements for currency areas. This theory has been rebirthed in the recent chaos observed in the Eurozone as a way of analyzing the economic costs and benefits of keeping the union.

1.3

Optimal Currency Area

Before a region has decided to engage in a currency region, it is important that the member countries evaluate whether they qualify as an Optimal Currency Area. Considering Mundell’s analysis, the following definition of an OCA can be used, “If the world can be divided into regions within each of which there is factor mobility and between which there is factor immobility, then each of these regions should have a separate currency that fluctuates relative to all other currencies13.” An optimal currency area does not by definition require the members to be of geographic proximity to each other or even to be in the same region so long as they meet several criteria. However, to meet these criteria, currency area members are often close because of cultural assimilations. Mundell’s theory leads to five criteria14: 1. Labor mobility across the region 2. Capital mobility across the region 3. Fiscal transfers across regions 4. Symmetry of idiosyncratic shocks across the region 5. Similar business cycles in the region Capital mobility refers to the lack of limitations between countries for free movement of capital throughout the region. Individuals should be able to pursue investment opportunities in other countries in the region to try to maximize profit. If there are no restrictions on mobility of capital, the country is said to have free mobility of capital. This refers to the ability of certain regions of the currency area to help the others. If one region is in trouble, with free fiscal transfer, the other regions can help. Symmetry of shocks and similar business cycles in a way can be analyzed together. These two essentially refer to the necessity for symmetry across countries both in shocks and in business cycles. This further unifies the countries and allows for an easier management by the central bank. If countries have different shocks and business cycles, the central bank will not be able to 13 Mundell, Robert. A Theory of Optimum Currency Areas. 14 Criteria taken from Mundell, Robert. A Theory of Optimum Currency Areas.

help one region because helping a failing region could possibly backfire and hurt the prosperous regions. This is also true for differing business cycles. To avoid the difficulty in managing such a region, it is best if the countries have similar industries, weather, and business cycles, which would further integrate the nations and allow for symmetry of shocks.

1.4

Costs and benefits of a monetary union

Shifting to a common currency brings with it both costs and benefits. It is important for a country to analyze both of these before entering a currency union. Some of the benefits of entering a currency union include: 1. Reduction of transaction costs because tariffs the removal of other anti-trade mechanisms so there are no efficiency losses across the region. 2. Ease of pricing, which makes comparing prices across borders much more clear. 3. Reduction of exchange rate risk throughout the region. This can be one of the large obstacles to trade. A common currency greatly increases trade, even more so than a fixed exchange rate regime (Rose 2000). 4. Increased credibility, especially those with less fiscal credibility by adopting the exchange rate of the more stable country (Frankel 1999). 5. Reduction of speculative attack risk (Frankel 1999). 6. Greater political integration and influence in international relations The costs of joining a monetary union include: 1. Lack of control of monetary policy. The country can no longer control its own monetary supply. To undergo a currency union, countries are forced to give up control of their monetary policy. Costs in such a scenario are greater than running a fixed exchange rate regime. If a country runs a fixed exchange rate regime, it can devalue, revalue, or leave but if it is in a currency union, it is much harder if not impossible to do so. 2. There could be larger economic fluctuations. 3. Transactional costs: these include converting to new currencies, changing prices, and the perception of inflation. Additional costs when the region is not an optimal currency area: 1. If the countries do not share similar business cycles or shocks, there could be budget deficits. 2. Financial costs. If the countries have different growth rates, inflation rates, unemployment rates, or GDP to debt ratios these all can pose huge problems because the countries will not be able to assimilate and the financial burden will be great.

Essentially, if the countries chosen for the currency union are not correctly picked, the union will not be optimum and the costs will be high but the opposite will be true if the countries are picked according to the criteria. This leads to the idea of Optimum Currency Areas, which was pioneered by Mundell (1961).

Is the Eurozone an Optimal Currency Area?

Incidentally, this is also a question that European officials are asking themselves, as evidenced through our interviews with European policy experts. To analyze whether the Eurozone is an Optimal Currency Area, we will look at each of the requirements that Mundell outlines and use them in analyzing the Eurozone. Through observing the criteria and looking at empirical data as well as opinions from European economists and politicians, we will see if the Eurozone meets the criteria for an OCA.

2.1 Labor mobility The first issue to discuss is whether labor mobility is achieved in the Eurozone area. The European Union does have as one of its four principles, free movement of labor. This is evidenced through the signing of the Schengen Agreement15 on June 14, 1985, in Schengen, Luxembourg between five16 of the ten nations of the European Economic Community and removed border controls for travelers within the region. While this treaty was meant to promote labor transfers and increase mobility of labor throughout the region, statistically this was not the case. We looked at unemployment statistics by age group from Eurostat, the European Commission’s statistical database and noticed that there are huge discrepancies. Unemployment for men and women less than 25 years of age in Germany in 2011 was 8.6% while in Spain and Greece 46.4% and 44.4% respectively17. If labor mobility were possible, the labor force would migrate from regions of low employment to regions of high employment. However, this is not the case. A big factor is the many languages of the Eurozone. As Dr. Carsten Brzeski of ING 15 The Schengen area and cooperation. Europa. http://europa.eu/legislation_summaries/justice_freedom_security/free_movement_of_persons_as ylum_immigration/l33020_en.htm 16 It was originally signed by Belgium, France, Germany, Luxembourg, and Netherlands and is now signed by 26 nations. 17 Unemployment rate by age group. Eurostat. http://epp.eurostat.ec.europa.eu/tgm/refreshTableAction.do?tab=table&plugin=1&pcode=tsdec46 0&language=en

stated, Europeans cannot find employment in another country if they do not know the language18. Additionally, the culture in each of the countries is so different that it can act as a barrier to labor mobility. Labor mobility today is mostly observed among the highly educated or low educated workers. The very highly educated workers have very specialized sets of skills, which allow them to move across borders. Additionally, the low educated workers often do not need the language skills to get employed. However, ultimately labor mobility will never be able to achieve the level of labor mobility required to become an OCA. Each country has centuries of history and it will be hard to form a common European identity where citizens are able to move freely among the member states. In summary, given the existing obstacles to labor mobility, in the face of legally united markets, it is obvious that the Eurozone is still a good distance away from becoming a unified labor market.

2.2 Capital Mobility Mundell also states the importance of having capital mobility to achieve optimal currency union status. There are two ways to measure capital mobility: price or quantity indicators. Research has shown that price is better for measuring integration than quantity (Bayoumi 1998). Feldstein and Horioka (1980) mention that to understand the level of capital mobility, it is important to look at the correlation between saving and investment. They state that if there is perfect capital mobility, there should be a low correlation between investments and saving because investors in one country do not need funds from domestic savers so can instead access international markets at world rates. In a similar way, savers can lend to foreign investors. As commonly assumed in economics, without these barriers, money will flow to the region where there is the most return on investment. So this would mean that domestic savings rates would not be equivalent to domestic investment rates. This is important in analyzing how open countries are in the Eurozone to capital mobility. According to Buch (1999), “the advanced transition economies have already reached a greater degree of openness for foreign capital than the southern members of the EU prior to their accession to the EU.” However, this does not mean that capital controls were completely removed upon accession into the EU. This article also states that even “After becoming members of the EU in 1981 (Greece) and 1986 (Portugal and Spain), the countries retained controls on capital flows up to 1992 (Spain and Portugal) and 1994 (Greece), respectively. Controls on capital flows outside Europe were even maintained until 1993 in Spain and 1995 in Greece” (Buch 1999). This means that capital flows took a long period to be allowed. This article essentially concludes with stating that while capital flows took many years to reach levels desired by Mundell, this criterion is on the path to becoming an OCA. As the integrative process of the 18 Personal Interview in Brussels (See Appendix 9.1.1)

Eurozone continues, capital flows can be expected to reach the level necessary to be an OCA.

2.3 Fiscal Transfers Furthermore, we look at the issue of fiscal transfers. Mundell wrote of the necessity for fiscal transfers to qualify as an Optimal Currency Area. Fiscal transfers are extremely useful in times of crises because it proves the solidarity among nations. Countries are willing to help each other in times of crises and be helped by countries doing well. As mentioned by Dr. Zsolt Darvas19 of Breugel, a Brussels based think tank, “In the EU, most member states contribute to the common budget by amounts equivalent to about 0.8-0.9 percent of their GDP, and receive EU funds in the range of 0.5-3.5 percent of their GDP. As a consequence, fiscal redistribution is much higher in the US than in the EU”. As shown, EU member states contribute largely insignificant amounts to the EU and receive small amounts as well. Fiscal transfers are incredibly important for a nation because they limit the amount of international borrowing that a country has to undertake and allows for risk sharing.

2.4 Symmetry of idiosyncratic shocks Another issue we look at is if there is symmetry of idiosyncratic shocks. Mundell stated that symmetry of shocks is the fundamental criterion for establishing the optimal currency area (Mundell, 1961). The more similar shocks are the more effective the common policies can be. Idiosyncratic shocks present substantial costs to economies because the central bank can no longer instill and control its own monetary policy. This puts the country at a huge disadvantage. If countries have similar shocks, common policies for the region will be equally beneficial for the region.

2.5 Business cycle integration Finally, we looked at the question of whether business cycle integration was or could be achieved in the Eurozone. It is important for the countries to have business cycle synchronization to achieve further assimilations and efficiency effects. This is not a highly contested point in the economic literature because countries with business cycles that are highly integrated tend to respond to shocks similarly, which helps all countries exit the shock in the quickest and most efficient way. Policy can be better suited to help all countries rather than just some. It seems as though this criteria is also not reached. “At the birth of the EMU in 1999, national business cycles appeared to be imperfectly synchronized across the members of EMU, and few thought that trade would rise substantially with monetary union. Together, these lead most to believe that EMU did not 19 Personal Interview in Brussels (See Appendix 9.4.2)

satisfy the requirements of an OCA” (Rose 2008). Increased trade between the countries will improve business cycle synchronization.

3. Monetary Policy in the EMU 3.1 Convergence Criteria of the European Monetary Union When creating a currency union, it is important to have rules of entry into the union. The Eurozone was no different in that it too had rules and regulations for the new and existing members to observe. These are the so-called Convergence Criteria and were established with the Treaty of Maastricht on the European Union. In this section we separate the criteria into the four categories stipulated by the Treaty establishing the European Community. These categories are: 1. Price developments 2. Exchange rate developments 3. Long-term interest rate developments 4. Fiscal developments 3.1.1 Price Developments The Treaty stipulates the following definition on price stability, “...shall mean that a Member State has a price performance that is sustainable and an average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than 1 ½ percentage points that of, at most, the three best performing Member States in terms of price stability. Inflation shall be measured by means of the consumer price index on a comparable basis taking into account differences in national definitions20.” The treaty then develops specific definitions of how to measure consumer price inflation. Concerning the statement “average rate of inflation,” the treaty mentions that inflation rate is calculated from the 12-month average of the Harmonized Index of Consumer Prices (HICP) over the previous 12-month average21. Concerning the statement “at most, the three best performing Member States in terms of price stability,” the best performing member states are chosen on the basis of unweighted arithmetic average of the rate of inflation in the countries with the lowest inflation rates, excluding outliers22. 20 Article 1 of the Protocol (No 13) referred to in Article 140(1) of the Treaty of the Functioning of the European Union. 21 ECB: Convergence criteria. www.ecb.int 22 ECB: Convergence criteria. www.ecb.int

3.1.2 Exchange Rate Developments The Treaty requires “the observance of the normal fluctuation margins provided for by the exchange-rate mechanism of the European Monetary System, for at least two years without devaluing against the euro23.” The Treaty also states: “The criterion on participation in the exchange-rate mechanism of the European Monetary System referred to in the third indent of Article 140(1) of the said Treaty shall mean that a Member State has respected the normal fluctuation margins provided for by the exchange-rate mechanism of the European Monetary System without severe tensions for at least the last two years before the examination. In particular, the Member State shall not have devalued its currency’s bilateral central rate against the euro on its own initiative for the same period24.”

3.1.3 Long-‐term Interest Rate Developments The Treaty requires “the durability of convergence achieved by the Member State...being reflected in the long-term interest-rate levels25.” The Treaty also stipulates “The criterion on the convergence of interest rates referred to in the fourth indent of Article 140(1) of the said Treaty shall mean that, observed over a period of one year before the examination, a Member State has had an average nominal long-term interest rate that does not exceed by more than two percentage points that of, at most, the three best performing Member States in terms of price stability. Interest rates shall be measured on the basis of long-term government bonds or comparable securities, taking into account differences in national definitions26.” The ECB will monitor the above-mentioned criteria by employing the following measurement tools. Concerning “an average nominal long-term interest rates” over “a period of one year before the examination,” interest rate is an arithmetic mean of the last 12-month period. Interest rates are measured “on the basis of harmonized long-term interest rates, which were developed for the purpose of assessing convergence27.” 3.1.4 Fiscal Developments As for the section on fiscal developments, the Treaty requires “The sustainability 23 Third indent of the Article 140(1) of the Treaty of the Functioning if the European Union. 24 Article 3 of the Protocol (No 13) referred to in Article 140(1) of the Treaty of the Functioning of the European Union 25 Fourth indent of Article 140(1) of the Treaty of the Functioning of the European Union. 26 Article 4 of the Protocol (No 13) of Article 140(1) of the Treaty of the Functioning of the European Union. 27 ECB: Convergence criteria

of the government financial position; this will be apparent from having achieved a government budgetary position without a deficit that is excessive as determined in accordance with Article 126(6)28.” The Treaty states “...at the time of the examination the Member State is not the subject of a Council decision under Article 126(6) of the said Treaty that an excessive deficit exists29.” The Treaty defines deficits and debts as excessive if the ratio of the planned or actual government deficit to GDP exceeds a 3% of GDP and government debt to GDP exceeds 60% of GDP.

3.2

European Central Bank

The role of the European Central Bank is clearly stated in Article 127(1) in the Treaty of the Functioning of the European Union30. This article states “the primary objective of the European System of Central Banks...shall be to maintain price stability.” It continues with the following objective: “Without prejudice to the objective of price stability, the ECSB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 on European Union.” Price stability is both an objective of the European Central Bank and the European Union as a whole. This treaty states that the primary objective of the European Central Bank is price stability. Article 127(2) of the Treaty of the Functioning of the European Union states basic tasks for the Eurosystem. This Treaty states that the European Central bank is tasked with defining and implementing of monetary policy for the euro area. It will also conduct foreign exchange operations. Another big task is the holding and management of the official foreign reserves of the euro area countries (portfolio management). Lastly the ECB must promote the smooth operation of payment systems. The Treaty also outlines some further tasks31. The ECB prints all banknotes for the Euro region. The ECB collects economic information from government agencies. The ECB will attempt to smoothly support policies from the other European institutions. Lastly, the ECB cooperates both within the European system and externally with foreign institutions and bodies to promote Eurosystem tasks.

28 Article 140(1) of the Treaty of the Functioning of the European Union. 29 Article 2 of the Protocol 140(1) of the Treaty of the Functioning of the European Union. 30 The Treaty of the Functioning of the European Union. http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:083:0047:0200:en:PDF 31 European Central Bank further tasks. http://www.ecb.int/ecb/tasks/html/index.en.html

4. History of the Euro Crisis32 To get a clear picture of the crisis, we will go through the sequence of events chronologically. The idea of a European currency has existed for quite some time. In 1849, Victor Hugo, the great French novelist predicted the European cooperation that exists today saying: “A day will come when all nations on our continent will form a European brotherhood... A day will come when we shall see ... the United States of America and the United States of Europe, face to face, reaching out for each other across the seas33." In 1929, Gustav Stresemann brought up the idea of a European currency34. From then to today, a series of institutions have been built furthering economic integration among the states. In 1973, the European Monetary Cooperation Fund was created to stabilize exchange rates. It was later succeeded by the European Monetary Institute on January 1, 1994. The EMI was dissolved with the introduction of the European Central Bank on June 1, 1998. In March of 1979, the European Monetary System came into existence fixing exchange rates through the European Exchange Rate Mechanism (ERM) which was later succeeded by the ERM II on December 31, 1998 to further counter inflation and stabilize exchange rates3536. Economic union was further legitimized at the European Council summit on June 14, 1988. At that summit, important decisions were made. While France and Italy supported a full monetary union, Margaret Thatcher of the UK opposed37. On February 7 of 1992, the Maastricht Treaty was signed. On January 1st of 1999, the currency union comes into existence38. On that date, it was merely used in non-physical form and used for wire transfers. However, not all countries in the European Union began to use the currency. The euro was initially adopted by eleven countries: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. In 2001, Greece joined the Euro. On January 1st, 2002 euro currency started to circulate among the Eurozone countries. In 2008, Malta and Cyprus joined. In December of that same year, European leaders agreed on a 200 billion euro stimulus plan to support the European economy. In 2009, Slovakia joined the 32 In this section, we use information from BBC Business: Timeline: The unfolding Eurozone crisis 33 Victor Hugo on August 21, 1849 in Paris in his opening address to the Peace Congress 34 Stresemann, Gustav. http://ec.europa.eu/economy_finance/emu_history/documentation/chapter1/19290909fr06speech ofgustavstresemann.pdf. Retrieved 19 March 2012. 35 12 July 2001) "The History of the Euro" Euro Homepage. http://specials.ft.com/euro/FT3O9H0O2PC.html 36 Dates and information from Taylor (2012) The Euro: Creation and Current Crisis 37 (7 February 1992) "The Maastricht Treaty: Provisions Amending the Treaty Establishing the European Economic Community with a View to Establishing the European Community" http://www.eurotreaties.com/maastrichtec.pdf. 38 Dates and information from Taylor (2012) The Euro: Creation and Current Crisis

Euro. Estonia, Denmark, Latvia, and Lithuania then entered the Exchange Rate Mechanism with the intention of adjusting their economies to join the euro. In April of that same year, the EU ordered France, Spain, and Greece to reduce budget deficits. In October of 2009, George Papandreou’s Socialists win the general electorate in Greece. In November, concerns began to grow among the Greek population about the government’s austerity measures. In December, Greece admitted its debt has reached 300 billion Euros, “the highest in [the country’s] modern day history39.” However, Papandreou repeatedly insisted that the country would not default. In January of 2010, a EU report recognized that there were large discrepancies in the reporting of Greek budget deficits. Greek deficit in 2009 was reevaluated to 12.7% of GDP as opposed to 3.7%, the number that had initially been reported40. This figure is particularly troublesome as it is four times greater than what had been stipulated by the EU convergence criteria. At that point of time, the European Central Bank insisted that Greece would not be forced to leave the union. On February 11th, 2010 the ECB tells Greece to continue making spending cuts, resulting in riots in the streets. In March, the euro continued to fall against the dollar. The Eurozone, in a joint project with the IMF, agreed on a safety net of 22 billion Euros to help Greece but at this time, no loans were made. In April, Greek borrowing costs increased and the EU re-evaluated Greek deficit numbers. Once again, they are worse than previously thought-13.6% instead of 12.7%41. On May 2nd, the Eurozone and the IMF agree on a 110 billion euro bailout package to support Greece42. At that time, the euro continued to fall against the dollar and the ECB scrutinized other countries’ debts and noticed problems in Ireland. In November, the EU and IMF agreed on a bailout package for Ireland consisting of 85 billion Euros43. At that point, the EU denied that Portugal is next for a bailout44. Even amidst the problems, countries still desired to join. On January 1st of 2011, Estonia joined the euro. Now the total number of countries in the Eurozone stood at 17. In February, the ECB established the European Stability Mechanism in the amount of 500 billion Euros, which was designed to be a permanent bailout 39 BBC: Greece’s debt reaches 300 billion Euros. http://news.bbc.co.uk/2/hi/business/8406665.stm 40 BBC: EU casts doubt on Greece economic figures. http://news.bbc.co.uk/2/hi/europe/8456216.stm 41 BBC: Greece’s budget deficit is worse than first thought. http://news.bbc.co.uk/2/hi/business/8637270.stm 42 BBC: Eurozone approves massive Greece bail-out. http://news.bbc.co.uk/2/hi/business/8656649.stm 43 BBC: Irish Republic 85bn euro bail-out agreed. http://www.bbc.co.uk/news/world-europe11855990 44 BBC: EU denies Portugal in line for aid package. http://www.bbc.co.uk/news/business11845046

fund45. In May, even after denying a bailout for Portugal, the ECB and IMF gave in and agreed on a 78 billion euro bailout for Portugal46. In June, the ECB stated that Greece would have to adopt further austerity measures to receive the next piece of its loan. Speculation that Greece would leave the Eurozone heightens47. In July, the Greek parliament accepted the new austerity measures and following that, the EU approved the last piece of the loan totaling 12 billion Euros. At that point, a second bailout for Greece is agreed upon. The Eurozone approved a 109 billion euro debt package, which is meant to put an end to the Greek crisis and prevent contagion for occurring48. In August, European Commission President Jose Manuel Barroso stated that the “debt crisis is spreading to countries outside of the Eurozone49.” Consequently, Spanish and Italian bond yields rose sharply and German ones fall. On August 7, the European Central Bank stated it would buy Italian and Spanish government bonds in an effort to limit the crisis from affecting large countries such as Spain and Italy50. In September, Spain passed an amendment to its constitution limiting budget deficits51. Italy joined in this effort and passed a 50 billion euro austerity budget to balance its budget by 2013. Both countries were met with protest and opposition by the masses. At that point, the European Commission predicted economic growth in the Eurozone to be as low as 0.2% in the second half of 201152. Greek Finance Minister Evangelos Venizelos said his country had been “blackmailed and humiliated” and a “scapegoat” for the EU’s incompetence53. Standard & Poor’s lowered Italy’s debt rating from A+ to A, a move that, according to Italian sources was implemented due to political pressures, not economic realities54. The IMF stated that the global economy had entered a “dangerous new phase55”. On September 22, the data showed that the

45 BBC: Eurozone agrees bail-out fund of 500bn Euros. http://www.bbc.co.uk/news/business12460527 46 BBC: Portugal’s 78bn euro bail-out is formally approved. http://www.bbc.co.uk/news/business13408497 47 BBC: Greece takes the Eurozone’s future to the brink. http://www.bbc.co.uk/news/business13842763 48 BBC: Greece aid package boosts stock markets. http://www.bbc.co.uk/news/business14246787 49 BBC: Euro Crisis: Barroso warns debt crisis is spreading. http://www.bbc.co.uk/news/business-14404852 50 BBC: ECB ‘to act’ over Eurozone debt crisis. http://www.bbc.co.uk/news/business-14439224 51 BBC: Italy and Spain agree tighter budgets. http://www.bbc.co.uk/news/business-14827742 52 BBC: EU predicts Eurozone is coming to a standstill. http://www.bbc.co.uk/news/business14930126 53 BBC 2011 http://www.bbc.co.uk/news/business-14969034 54 BBC: Italy’s sovereign debt rating cut by S&P on growth fear. http://www.bbc.co.uk/news/business-14981718 55 BBC: IMF http://www.bbc.co.uk/news/business-14984087

Eurozone’s private sector shrank56. On September 23, IMF head Christian Lagarde urged nations to “act now and act together” to get on the path to recovery57. David Cameron took the first step calling for swift action. U.S. Treasury Secretary Timothy Geithner told Europe to prevent the crisis from spreading further58. On October 6, the Bank of England injects 78 billion pounds into the UK economy through quantitative easing59 and the European Central Bank unveiled emergency loan measures60. At this point, Jean-Claude Trichet of France stepped down as president of the ECB and was replaced by current president, Mario Draghi of Portugal. In subsequent weeks EU leaders took part in summits and meetings attempting to reach an accord on what to do. However, getting all 27 leaders of the EU to agree to a treaty proved to be difficult. 2012 began negatively for the Eurozone. On January 13 of this year, Standard & Poor’s downgraded 9 Eurozone countries61. Standard & Poor’s also downgraded the EU bailout fund, European Financial Stability Facility, to AA+62. The EU agreed on a fiscal pact making it more difficult for nations to break budget deficits. The UK and Czech republic, however, did not take part in this but the other 25 nations of the EU signed the treaty63. For the next couple weeks, Greece took part in negotiations with its private lenders, the troika of the European Commission, the European Central Bank, and IMF. On February 10th, Greece agrees to accept the demands made of it by its lenders leading to more protests64. On February 22, a survey reported that the Eurozone service industry had shrunk, which increased fear of an imminent recession65. The following day, the European Commission predicted that the Eurozone economy would contract 56 BBC: Eurozone business shrinks for the first time in two years. http://www.bbc.co.uk/news/business-15016916 57 BBC: Global economy needs collective action now. http://www.bbc.co.uk/news/business15041674 58 BBC: Geithner wants ‘firewall’ against crisis spreading. http://www.bbc.co.uk/news/business15044357 59 BBC: Bank of England injects further 78billion pounds into economy. http://www.bbc.co.uk/news/business-15196078 60 BBC: Ecb holds interest rates and offers loans to banks. http://www.bbc.co.uk/news/business15200131 61 BBC: France loses AAA rating as euro governments downgraded. http://www.bbc.co.uk/news/business-16552623 62 BBC: Standard & Poor’s downgrades the EU bailout fund EFSF. http://www.bbc.co.uk/news/business-16586807 63 BBC: EU Summit: UK and Czechs refuse to join fiscal compact. http://www.bbc.co.uk/news/world-europe-16803157 64 BBC: Athens clashes in Greece over Greece Eurozone austerity deal. http://www.bbc.co.uk/news/world-europe-16981783 65 BBC: Eurozone service sector contracts in February. http://www.bbc.co.uk/news/business17125061

by 0.3% in 201266. In March, the unemployment rate rose to new levels67. However, shockingly, a report this month showed that the Eurozone’s retail sales increased in January by 0.3%, which seemed to point towards economic recovery68. On March 13, the Eurozone backed a second Greek bailout of 130 billion Euros69. The IMF also backed the bailout. The Organization for Economic Co-operation and Development (OECD) stated that the Eurozone needed to double its bailout fund to 1 trillion Euros70. German Chancellor Angela Merkel adamantly stated that she would only back this as a temporary increase. On April 12th, Italian borrowing costs increased as investors showed their continuing fear about the country’s ability to reduce its debt71. The next day, Spain also experienced investor hesitation and Spanish government’s 10-year cost of borrowing rose to 6%, showing fear of the country’s creditworthiness72. On April 18th, the Italian government reevaluated its growth forecast and then stated a contraction of 1.2% as opposed to the initial guess of 0.4%73. The following months saw elections in Greece; however, Greece failed to form a coalition government. On June 9th, Spain’s Economic Minister Luis de Guindos said the country planned to make a formal request for 100 billion Euros in loans to help support its banks74. Spain continues to have problems and on June 12th, Spain’s borrowing costs rose to 6.81%, a euro-era record high75. Fears rose on June 15, as UK chancellor Gordon Brown expressed his concerns about contagion effects and warned that France and England may need bailout76. Through the rest of the year of 2012 and beginning of 2013, European leaders continued to meet to decide on final plans for failing nations. The entirety of the Eurozone however patiently awaits the general Parliament elections of 2014 and European leaders continue to talk about large changes to come in to place with these new elections. 66 BBC: EU says Eurozone economy to shrink in 2012. http://www.bbc.co.uk/news/business17138207 67 BBC: Eurozone unemployment continues to rise. http://www.bbc.co.uk/news/business17219160 68 BBC: Surprise increase for Eurozone retail sales in January. http://www.bbc.co.uk/news/business-17255982 69 BBC: Eurozone group backs second Greek bailout. http://www.bbc.co.uk/news/business17338100 70 BBC: OECD urges Eurozone rescue fund boost to 1tn Euros. http://www.bbc.co.uk/news/business-17521080 71 BBC: Italy’s borrowing costs rise in bond auction. 72 BBC: Shares hit by worries over Spain. http://www.bbc.co.uk/news/business-17706434 73 BBC: Italy slashes its 2012 growth forecast. http://www.bbc.co.uk/news/business-17759429 74 BBC: Spanish banks to get up to 100bn Euros in rescue loans. http://www.bbc.co.uk/news/business-18382659 75 BBC: Spain borrowing costs hit euro-era record high. http://www.bbc.co.uk/news/business18405729 76 BBC: Gordon Brown says France and Italy may need bailout. http://www.bbc.co.uk/news/ukpolitics-18460596

5. Reasons for the Crisis In this section, we investigate several factors that have been identified as the root causes of the Eurozone crisis.

5.1 Exceptions of Standards for New Members In this section, we discuss some of the countries, which were allowed admittance to the Eurozone, even though they clearly did not meet the criteria stipulated by the Maastricht Convergence Criteria. There were three countries for which major exceptions had to be made. These three are Greece, Italy, and Belgium. However, smaller exceptions to some of the criterion had to be made for a larger set of countries, which included Portugal, Spain, the Netherlands, and Austria. Not only did this pose a problem at the conception of the EU but it poses a problem of precedent. Lavrac77 address this issue stating, “Official representatives of the EU emphasize that for the new member countries there will be no exemptions or softening of the rules, the Maastricht convergence criteria will apply in their strict interpretation. Does the principle of equal rules require that all exemptions given to “old” EMU members should be extended also to “new” EMU members?” Currently, there is no clear answer. 5.1.1 Greece First and most notably is the case of Greece. As mentioned in the timeline above, Greece has had many problems with reporting accurate statistics. This issue has been so crucial that the EU has issued a report on Greece’s membership. As the article states, “This Council Decision repeals the derogation to the Treaty covering Greece, so as to enable it to adopt the single currency on January 1 200178.” People criticize Greece stating that it had to lie to enter the Eurozone. This is not correct. As this article states, the European Commission knew that Greece did not meet the requirements, but still allowed it to enter the union. However, it is important to try to understand the Commission’s decision. Europa provides a summary on the act: “At the time of the transition to the third stage of economic and monetary union (EMU), Greece did not fulfill the convergence criteria (Decision No 98/317/EC) and was covered by a derogation laid down in Article 122 of the Treaty. Every two years, or at the request of the Member State concerned, a report by the Commission and the European Central 77 From Jean Monnet Centre of Excellence 78 2000/427/EC: Council Decision of 19 June 2000 in accordance with Article 122(2) of the Treaty on the adoption by Greece of the single currency on 1 January 2001

Bank (ECB) examined whether the convergence criteria were met. Greece requested that the derogation be repealed on 9 March 200079.” The Council used reports by the Commission and ECB stated80: • Greece fulfilled the criterion relating to the average rate of inflation81 • Greece did not have excessively high government debt82 • Greece had been a member of the European Monetary System and the ERM I for two year without devaluing its currency’s central rate • Greece met the long-term interest rate value83 • Greek domestic legislation was compatible with the Treaty and the Statue of the European Central Banks (ESCB) The Council concludes that it “considered that Greece had achieved a high level of sustainable convergence and that it fulfilled the necessary conditions for the adoption of the single currency. The derogation relating to Greece was repealed on 1 January 200184.” 5.1.2 Italy There were many issues that arose with Italy. First, Italy “had not been participating in the European exchange rate mechanism ERMII for the whole two years, but the stability of its exchange rates was obviously assessed also on the basis of preceding results or future expected developments85.” Italy knew it would have problems in receiving approval from the European Union and so was stuck at a crossroads. “Italy faced a dilemma: the Italian government was a supporter of the EMU, but in the mid-nineties its public finance was not in line with the Maastricht criteria86.” The Italian government was aware that the country was far from achieving the criteria. “In 1995 the budget deficit was still at 79 Europa: Greece’s membership in the single currency. http://europa.eu/legislation_summaries/economic_and_monetary_affairs/institutional_and_econo mic_framework/l25059_en.htm 80 Bullets taken from Europa: Greece’s membership in the single currency. http://europa.eu/legislation_summaries/economic_and_monetary_affairs/institutional_and_econo mic_framework/l25059_en.htm 81 Inflation rate of 2% was lower than the reference value of 2.4% 82 This statement is puzzling because a report by the European Central Bank states that in 1999 “the debt ratio was 104.4%, i.e. Far above the 60% reference value.” Debt was forecasted to decline to 103.7%, which does not constitute a major approximation to the reference value. (Presentation of the ECB Convergence Report to the Committee on Economic and Monetary Affairs of the European Parliament). 83 Interest rate reached 6.4% which was lower than the reference value of 7.2% 84 Europa: Greece’s membership in the single currency. http://europa.eu/legislation_summaries/economic_and_monetary_affairs/institutional_and_econo mic_framework/l25059_en.htm 85 Fulfillment of Maastricht Convergence Criteria and the Acceding Countries. Ezoneplus 86 Italy’s Admission to the Third Stage of the European Monetary Union: A Case Study on the Diplomacy of European Integration.

7.6% of GDP-well above the ceiling of 3 percent. The gross debt was at 123.2 percent of GDP, and still growing. Inflation was over 5%, far above the European average. Long-term interest rates, signaling market expectations about convergence, remained at 12.2 percent. The lira had not yet rejoined the Exchange Rate Mechanism (ERM), from which it had been ejected in 199287.” After much negotiation, it seemed as though the other European nations would allow Italy to join, even despite its lack of achieving the criteria. The Bundesbank unveiled a new approach to deal with the Italian dilemma. “Even if a country achieved the 3 percent objective, so went the argument, it had to prove that the goal could be attained in the long run. Budget cuts had to be structural. The level of overall debt was emphasized as a key indicator of sustainability88.” In this sense, it created a loophole for Italy. This was mirrored in the EMI’s Annual Report. The institute wrote “short-term or one-off measures, which are only effective in one year, which improve the current budgetary situation at the expense of future budgets, or which have mere presentational effects, cannot be regarded as contributing to sustainability89.” Rather than looking at its inability to meet current criteria, these two influential organizations decided to look at the possibility of Italy meeting the criteria in the future. 5.1.3 Belgium Even for the small core of countries, which were initially marked to form the Eurozone, the convergence criteria had to be adjusted. In the case of Belgium this meant allowing Belgium entrance even though in 1997 its debt to GDP ratio was above 120% and in 1998 it was still above 115%. To allow Belgium to join the euro, the debt criterion had to be qualified. Instead of meeting the 60% ceiling, countries had to approach the 60% ceiling “at a satisfactory pace90.” Additionally, Belgium used creative bookkeeping to hide its real deficit to GDP ratio91. 5.1.4 Gross Government Debt The above nations were not the only ones in trouble. In fact, most of the nations allowed admittance to the Eurozone did not meet the criteria. First we will discuss gross government debt. Graph 16 looks at Gross Government debt two years prior to entry in 1997 and 1998. For this criterion, 60% was the limit. The only countries that met this criterion in these years were France, Luxembourg, 87 Italy’s Admission to the Third Stage of the European Monetary Union: A Case Study on the Diplomacy of European Integration. 88 Italy’s Admission to the Third Stage of the European Monetary Union: A Case Study on the Diplomacy of European Integration. 89 European Monetary Institute, Annual Report, April 1997, page 19. 90 The Economist: Maastricht Follies 91 Maastricht Criteria of…Divergence? Tomas Paleta.

Portugal, and Finland. In 1998, Denmark was barely above the limit, Italy was at 115% debt, and Netherlands was above 65%. This criterion was clearly ignored even though none of the countries seemed to be making moves in the right direction. 5.1.5 Gross Budget Deficit We now move on to discuss gross budget deficit. We use Graph 17 to observe Government budget deficit two years prior to entry. For this criterion, the limit was 3%. Most countries met this criterion without a problem; however Portugal and Spain did not meet this criterion. A big issue with this criterion was that in the case of France, creative accounting was involved meaning more countries would not have met the criteria if they had reported accurately. 5.1.6 Average Yearly Inflation Graph 18 shows the average yearly inflation in the Eurozone from 1999-2007. The Graph shows that the criterion was met by all EU countries that initially joined.

5.2 Dealing with Non-‐Adherence to Standards by existing members This problem of non-adherence to the rules has been a problem since the early years of the Euro. John Lanchester writes in the New Yorker, “The guiding principle of the currency, which opened for business in 1999, were supposed to be a set of rules to limit a country's annual deficit to three per cent of gross domestic product, and the total accumulated debt to sixty per cent of GDP. It was a nice idea, but by 2004 the two biggest economies in the Eurozone, Germany and France, had broken the rules for three years in a row92.” When the large countries are breaking the rules, regulation becomes problematic. Dr. Zuleeg93 mentioned that at the European level, three questions arose: How do you decide who fulfills the rules since there is room for interpretation? What do you do with the countries that do not currently fulfill the criteria but are moving in the right direction? On what level can you exclude countries that want to be part of the project? Zuleeg addressed this issue by stating the two main questions European policy makers should be asking as they decide what to do with struggling member states. First, there is the question of flexibility, whether to strictly apply the rules or allow for discretion, particularly in a crisis. His second question deals with the size of a country and its adherence to the rules. Is it the same if a small country breaks the rules as opposed to a large country? He concluded this part of the 92 John Lanchester, "Euro Science," New Yorker, 10 October 2011. 93 Personal Interview in Brussels (See Appendix 9.4.4)

interview by stating that rules alone cannot fix the problem. “We can see that already since putting increasingly pressures on countries like Greece does not result in a significant reduction of debt because the situation in Greece is disastrous. Instead of imposing more rules, we need to focus on the economic side, on growth” (Zuleeg). The problem in the long-run about the non-adherence to the rules is that the precedent has been set. At this point, letting countries enter the Eurozone without fulfilling the rules or making any effort to adhere to them is problematic because this means that if rules are set in the future, they too can be ignored. 5.2.1 Greece The case of Greece is of crucial importance. In many ways, the crisis of Europe has been termed the crisis of Greece. Greece is not the singular problem, but it is worth noting that Greece never met the criteria. It was allowed in the Eurozone because the ECB believed Greece was making progress. Greece had already violated the criteria and as is shown in the data, did not make progress towards meeting the criterion, as the EU had hoped. Greek’s debt has always been substantially above the Eurozone average. More important for the unfolding of the Eurozone crisis, though, is the large increase of the debt to GDP ratio from about 100% pre-crisis to 165% in 2011. As Dr. Doukas states, “Net borrowing by the Greek government during the 1999-2007 period, before the crisis was 57% of GDP.” Looking at these figures, we can tell that Greece was a large net borrower. However, by 2009, the net external debt of Greece rose extraordinarily. In Greece it reached 78.9% of GDP. What this all shows is that the large-scale bailout of banks that occurred in this period led to a massive increase of external public sector debts. This means that the government took the role of the debtor. Greece did not make any viable approximation towards the criterion, and in fact it seems as though Greece’s situation got worse. However, this is due in part to the fact that Greece had to adjust its figures to be allowed into the Eurozone so it is possible that part of the problem is hidden in the lack of truthful data. Graph 18 then points out that average yearly inflation rose by 3% in Greece from 1999-2007. While Greece met this criterion originally, it completely ignored it once in the Eurozone. 5.2.2 Italy Italy was another country that did not meet the original criteria but was allowed since it seemed to be making approximations towards the criterion. However, as is shown in the literature and graphs, the crisis highly affected Italy’s ability to achieve the criteria. Graph 6 looks at government debt as a proportion of GDP. The Maastricht Treaty requires that public debt cannot exceed 60% of GDP. Clearly the public debt to GDP ratios in Italy never met the 60% criterion since it was around 100% throughout the pre-crisis years. It then increased to 120% in

2011. Graph 18 then mentions the yearly inflation in Italy. Inflation in Italy rose by more than 2% from 1999-2007. Italy originally met this criterion but ignored it once in the Eurozone. Finally, Graph 20 shows the deficit to GDP levels. While they could not exceed 3%, in 2012 Italy was just below the limit, at 2.9% so met the criterion. 5.2.3 Belgium The last major country that was addressed above was Belgium, which also never met the criteria. Graph 18 shows that Belgium’s inflation rate rose by almost 2% from the period of 1999-2007. Graph 19 shows the general government gross consolidated debt for the Eurozone countries. Belgium is started at about 115% government debt and while it did attempt to achieve this criterion and lower its debt, once the global economic crisis hit in 2007, Belgium’s debt rose to about 100% at 2010, still not meeting the criterion. Belgium did attempt to make approximations to the criterion but was unable to achieve it. Graph 20 shows the deficit to GDP levels. Belgium met this criterion at exactly 3% in 2012. 5.2.4 Portugal As Dr. Doukas states94, net borrowing by the Portuguese government during the 1999-2007 period, before the crisis was 30% of GDP. Portugal, too, was a net borrower. However, by 2009, the net external debt of Portugal rose, as did Greece’s. In Portugal it reached 77.4% of GDP. Portugal, as did Greece, bailed out banks and increased its public sector debt during this time to figures surpassing the requirements. Graph 18 shows that Portugal’s inflation rate rose dramatically, by about 2.75%. Graph 20 then shows the deficit to GDP levels. Portugal’s deficit to GDP level in 2012 was 5%, much higher than the reference value. 5.2.5 Ireland Dr. Doukas then analyzed the case of Ireland. In Ireland for the period from 1999-2007, before the crisis, net borrowing was at -10% of GDP, making Ireland a net creditor. While Ireland was originally doing well in this regard, once 2009 hit, Italy’s net external debt rose to 42.9% of GDP95. The Irish public sector external debt from 2007-2009 rose from -10% of GDP to 70.6% of GDP96. Graph 20 shows that this increased to 118% in 2012. Graph 18 shows that Ireland’s inflation rate rose the most. It rose by more than 3% in the years from 19992007. A big issue for Ireland is its deficit. Graph 20 shows that in 2012, Ireland’s deficit to GDP was at 8.4%, the highest in the Eurozone. 94 Doukas. Another Euro Peril: EU Current Account Imbalances 95 Doukas. Another Euro Peril: EU Current Account Imbalances 96 Doukas. Another Euro Peril: EU Current Account Imbalances

5.2.6 Spain Dr. Doukas also provides insight on the case in Spain. In Spain for the period from 1999-2007, before the crisis, net borrowing was at -2% of GDP, also making Spain a net creditor. Spain was achieving the criterion of net borrowing, but once 2009 hit, Spain’s net external debt rose to 47.3% of GDP97. To further our understanding of the case of Spain, we use Graph 6. Observing the graph, we can tell that Spain’s public debt to GDP ratio remained under the 60% threshold until 2010, reaching 70% in 2011. The case in Spain was more affected by the housing bubble going out of hand but has recently become somewhat of a debt and deficit problem, but we can see that Spain, for the most part, met the criterion. Graph 18 shows the inflation rate situation in Spain. Spain’s inflation rose by more than 3% from 1999-2007 once in the union. Graph 20 shows that in 2012, Spain’s deficit to GDP level was at 8%, the second highest in the Eurozone. 5.2.7 France and Germany It is an issue when small countries break the rules, but when large ones break them, problems arise. France and Germany are arguably the most powerful countries in the Eurozone and very influential in decision-making. France and Germany originally were not problem countries and are still not the problem countries. However, they have violated the criteria, which inadvertently sets a bad precedent. Graph 19 shows the general government consolidated gross debt and France originally was at about 70% debt to GDP so never met the 60% criteria. However, France did make approximations to the Maastricht required level, but once the crisis hit, debt to GDP rose to over 80%. Germany originally met the criteria but ever since it joined the Eurozone German debt has been increasing, much before the global economic crisis. In 2010, German debt to GDP had almost reached 80%. Then there is the issue of inflation rates. France and Germany’s inflation rate remained low compared to the others according to Graph 18. France’s rose by about 1.6% and Germany’s by almost 1.5%. Germany’s increase was the second lowest after Finland. Graph 20 then addresses the deficit to GDP levels in 2012. France did not meet this criterion and was at 4.5% deficit to GDP levels. Germany did meet this criterion and in fact was the country with the lowest deficit to GDP levels, at 0.2%. France and Germany, while quick to demand strict adherence to rules for other countries, have been accused of being much gentler to itself. As Antonio Martino mentions, “The fiscal constraints introduced with the new currency must be criticized not because they are undesirable—in my view they are a necessary component of a liberal order—but because they are ineffective. This is amply 97 Doukas. Another Euro Peril: EU Current Account Imbalances

evidenced by the “creative accounting” gimmickry used by many countries to achieve the required deficit to GDP ratio of 3 percent, and by the immediate abandonment of fiscal prudence by some countries as soon as they were included in the euro club. Also, the Stability Pact has been watered down at the request of Germany and France98.” Additionally, “the failure of the pact to enforce its provisions on France and Germany was believed to have provided ammunition against joining the Eurozone. This is cited as another major example of Franco-German ‘bullying off’ other member states when it suits them. More Eurosceptic commentators assert that the pact promotes neither stability nor growth, and remark that it has been applied inconsistently, after the Council of Ministers failed to apply sanctions against France and Germany99.” Rules are being created but they are clearly not being upheld and enforced equally. France and Germany have a large number of votes on the Council of Ministers100, which approves sanctions, so it is understandable that these countries will not be accused as often.

5.3 Violations of Optimal Currency Rules 5.3.1 Labor Mobility One of the structural problems that persists but is not easily addressable is the issue of free labor mobility. As Dr. Rolf Campos101 of IESE Business School stated in an interview, “In Europe, you have free mobility in theory but not in practice. It is not very easy to move to another region” In Spain, unemployment has reached extremely high numbers while in regions such as Germany the figures are not as drastic. This is not promoting economic prosperity in the region because people who want to move from one country to the other are still faced with barriers. While a Spanish man might want to find employment in Germany, he will be met with many implicit barriers such as language, culture and family. For Spain, Campos mentioned that the situation is unique because Spanish people have traditionally struggled with speaking other languages so it is uncommon for a typical Spanish person to master a language well enough to move to the other nation. In relation to culture and family, Spanish people enjoy 98 Milton Friedman and the Euro. Cato Institute 99 The Balkans: Foreign Direct Investment and EU Accession 100 The Council of Ministers of the EU: “The Council of Ministers, also called the Council of the European Union, or simply, the Council, is one of the two European Union legislative bodies -- the other being the European Parliament. Unlike the European Parliament, whose 736 members are directly elected by, and answerable to, the people, the Council is made up of 27 ministers, one from each of the EU's member states. Council members, therefore, represent their government's viewpoints. The size of a member state's population determines the number of votes its minister wields.” 101 Personal Interview in Brussels (See Appendix 9.1.2)

staying in their culture and with their friends and family, stated Campos102. However, a deeper problem is that in Spain people purchase homes, which is not the norm in the Eurozone. Since home prices have drastically dropped, Spanish people prefer to stay trapped in their home than sell it for much cheaper than it is worth. Campos discussed the statistics as well103. He mentioned that while labor mobility is not seen in full, some labor mobility is still present. This is in the highly skilled workers and the least skilled workers. This is because someone who is highly skilled can find employment across the region and someone who has low skills can perform the same type of labor in another country without much of a need to learn the language. This discussion with Campos concluded in discussing whether the region would be more prosperous with higher labor mobility. He stated “as long as you assume that people will move from one nation to another to find better employment, having more labor mobility would greatly affect the Eurozone.” While it is tough to promote labor mobility, instilling practices or programs that could increase the amount of labor mobility would greatly benefit the region. 5.3.2 Capital Mobility This is important in analyzing how open countries are in the Eurozone to capital mobility. According to Buch (1999), “The advanced transition economies have already reached a greater degree of openness for foreign capital than the southern members of the EU before their accession to the EU.” However, this does not mean that capital controls were completely removed upon accession into the EU. This article also states that even “After becoming members of the EU in 1981 (Greece) and 1986 (Portugal and Spain), the countries retained controls on capital flows up to 1992 (Spain and Portugal) and 1994 (Greece), respectively. Controls on capital flows outside Europe were even maintained until 1993 in Spain and 1995 in Greece” (Buch 1999). This means that capital flows took a long time to be allowed. It took many years for these countries to allow capital flow. This article essentially concludes with stating that while capital flows took many years to reach levels desired by Mundell, this criterion is on the path to become an OCA. As the integrative process of the Eurozone continues, capital flows can be expected to reach the level necessary to be an OCA. 5.3.3 Fiscal Transfers The EU is based on unity, but economically, the EU does not provide fiscal transfers. The EU does not have many fiscal transfers, such as the automatic stabilizers seen in through the Federal Reserve in the U.S. The European

102 Personal Interview in Brussels (See Appendix 9.1.2) 103 Personal Interview in Brussels (See Appendix 9.1.2)

Central Bank cannot monetize debts for example104. It cannot buy government bonds from a member country. This has been a huge problem in the recent crisis because national banks have had to back their government’s bonds and the ECB has not been able to do much. The other way for this to occur is for the ECB to step in as a lender of last resort. Megan Greene, Director of European Economics at Roubini Global Economics, specializing in the Eurozone crisis, mentions that she does not think it ever will because there are too many ideological barriers. The ECB also cannot act as a lender of last resort. This is an odd distinction among Central Banks around the world and in some ways seems to be debilitating given the recent financial struggles. Fiscal transfers had not really been envisioned at the beginning of the Eurozone, hence the Convergence Criteria, but considering the recent crisis, the European Central Bank has bought government bonds and is helping suffering nations105. This criterion could be observed but the EU will have to undergo an analysis of its ideology. 5.3.4 Symmetry of Idiosyncratic Shocks In the Eurozone, because of the novelty of the region and the differences in cultures and histories, full symmetry of shocks is not observed. It is possible to make the case that in a situation such as that of the Eurozone, where there is not a complete symmetry of idiosyncratic shocks, the system does not help everyone economically at the same level. Such a system greatly benefits countries such as Germany, which are in booms, but hurts countries such as Greece, which are struggling. It also appears that the more countries are added to the system, the less homogeneous the union becomes. The system began as a small union with a few countries which were relatively homogeneous, but the rapid expansion and spread of the union to encompass as many countries as possible has led the system to become more heterogeneous and less assimilated in terms of shocks. A much smaller currency union is more likely to pass this OCA test than a larger one, such as the Eurozone today. 5.3.5 Business Cycle Integration Rose’s paper states that at the beginning of the implementation of the EMU, 104 According to the treaties, the ECB cannot monetize det. The ECB cannot be a lender of last resort. 105 “Currently, the regular operations are complemented by euro liquidity-providing operations with a maturity of (around) one, six, twelve and thirty-six months as well as US-dollar liquidityproviding operations. In addition, the Eurosystem has launched two Covered Bond Purchase Programmes (CBPP, which ended in June 2010 and CBPP2, which started in November 2011) in to order to purchase euro-denominated covered bonds and, since 10 May 2010, it has conducted interventions in debt markets under the Securities Markets Programme (SMP). The liquidity provided through the SMP is currently absorbed by weekly collections of fixed-term deposits.”European Central Bank: Eurosystem. Open Market Operations.

there was little business cycle synchronization but that through direct and indirect measures, the “EMU may have created a virtuous circle that might make currency union closer to being sustainable” (Rose 2008). However, the EMU has been in place for a very short amount of time and it is quite difficult to quantify whether the EMU will achieve this OCA criteria. The EMU has no similar precedent, even though it is often compared to the US for OCA analysis, and this makes making speculative predictions difficult. However, on this OCA criterion, the EMU may not have currently reached it, but it might be on a path to achieve this criteria (Rose 2008). In the early years, business cycle integration was lacking, but significant improvements have been made since. As time progresses the requirements should be fully achievable. This requirement should be achievable as time progresses. Looking at all the distinctions to become an OCA, there are reasonable doubts that the European Monetary Union qualifies as an Optimal Currency Area.

5.4 Current Account Imbalances Another explanation for the Eurozone crisis has been linked to the massive current account imbalances, with many EU peripheral countries experiencing large current account deficits and others, primarily Germany, experiencing the opposite. In accounting terms, the current account along with the capital account makes up the balance of payments. The balance of trade is the biggest and most important sub-account of the current account. It measures exports minus imports and thus determines the status of a country’s foreign trade. If imports exceed exports, a country will run a trade deficit and therefore a current account deficit. This is equivalent to running a capital account surplus. A capital account surplus means that domestic savings fall short of domestic investment, forcing the country to borrow the difference from abroad. Observing large and persisting current account imbalances has been the subject of debate among economists. Europe is no different and observing some of the graphs shows that the system of imbalances may not be sustainable. Graph 7 provides the Eurozone member countries’ current account balances as a percentage of GDP for the years 1985 and 1995. Graph 8 shows the same data but for years 2000 and 2006. In Graph 7, we see the changes that occurred from 1985 to 1995. The Euro-12 did was not highly affected. However, for most countries, there is a visible shift from a greater deficit in 1985 to a much-reduced one in 1995 and in some cases, even a shift to a surplus. However, Portugal, Spain, and Denmark did show a shift from a surplus to a deficit in these years. We then use Graph 8 to analyze another two time periods, 2000 and 2006. In these periods, we first notice a huge increase in deficit for many countries, Portugal, Spain, Ireland, and Italy from the 1995 period. This is offset by a huge increase in surplus for other countries from 1995 to 2000 for countries such as Belgium, Denmark, Finland, and the Netherlands. However, from 2000 to 2006,

the shifts are not as great. Portugal, Spain, and Italy for example decrease their current account deficits. For countries in surplus, there was a bit of everything. Belgium decreased its surplus, Germany changed its deficit to a surplus, Denmark changed its deficit to a surplus, and Finland’s surplus decreased. As stated by Ahearne, Schmitz, and Von Hagen, “One interpretation of the evolution of current account balances under EMU is that the increased dispersion of current account positions has been driven by trade flows that reflect shifts in relative competitiveness within the euro area106.” Going off of such an assumption, we use Graphs 9, 10, and 11 to show the current account balances under the EMU as a percentage of GDP. Looking at these figures, we can attribute the differences between the countries in deficit and those in surplus for their current account as being based upon “persistent differences in inflation rates among countries107.” It is because of these differences that “euro area economies have experienced very sizable swings in the real exchange rates visa-vis their peers108” as shown in Graphs 9, 10, and 11. An important question is how the ECB tolerated these oversized current account deficits that included investments, which in retrospect fueled the real estate bubbles in some of these countries. Doukas states “The ECB and other Eurozone institutions have done very little to address the rising current account imbalances” (Doukas 2). This is crucial because “disproportionate and longlasting external deficits are an existential threat to a currency union which is analogous to a fixed-exchange rate regime” (Doukas 3). It is difficult to believe that the Eurozone institutions were unaware of these developments. Rather, it seems that the ECB and other EU policymakers thought that interest rate convergence among the institutions would reduce economic disparities and promote economic integration and prosperity in the region. The surplus in these nations was able to offset the deficits of the others. To understand this, we must observe the inflation rate divergences among the EMU states. Graphs 12, 13, and 14 show the real exchange rates for the period before entering the EMU to today. Graph 13 and Graph 14 show how the exchange rates increased for Ireland, Italy, Greece, Portugal, Spain, Netherlands, Finland, and Belgium. Conversely, Graph 15 shows the decrease in the real exchange rate for Germany, France, and Austria. The strong performance of German exports might thus be related to the inflation rates in Germany. According to this view, “wage restraint facilitated by a decline in unionization in Germany’s labor market, has kept growth in unit labor costs well below the euro are average, boosting the competitiveness of German 106 Ahearne, Schmitz, Von Hagen: Current Account Imbalances in the Euro Area. 107 Ahearne, Schmitz, Von Hagen: Current Account Imbalances in the Euro Area. 108 Ahearne, Schmitz, Von Hagen: Current Account Imbalances in the Euro Area.

exporters109.”

5.5 Decision-‐Making within the EU 5.5.1 Lags in Decision-‐Making A lag in decision-making is the time it takes for policymakers to decide on a solution and then implement it. There are inner and outer lags. An inner lag is the actual time it takes to vote on a plan. An outer lag is the amount of time it takes to implement that plan and reap the benefits. In economics, these lags can be used to describe how fiscal and monetary policy work together. Decisionmaking creates lags of both kinds. There are large inner lags because it takes a significant amount of time to reach consensus. Additionally, there are large outer lags because it takes time for the monetary solutions to affect the individual citizens. This issue became apparent from our talks with European Commission officials, where a common theme was that the current European way of negotiating consists of muddling through the issues and buying time. This has proven to be inadequate in crises such as this. Officials sit, think, negotiate, and then revisit the problem. Each official is focused more closely on the short-run effects on his or her nation than on the long-term effects for the European system as a whole. 5.5.2 Structure of Decision-‐Making The structure of decision-making within the European Union has been another contributing factor to the Eurozone Crisis. Voting in the European Union is always a tricky subject because countries do not enjoy giving up sovereignty. Many of the decisions are made unanimously. This is a good way to entice countries to join because it means that they will not only have a voice, but also a veto power on any agreement. Currently, some agreements are being made with majority ruling, but as far as economic issues are concerned unanimity is desired110. As Dr. Amandine Crespy stated, “There should be a shift of the voting process of the EU. You cannot decide on so many policy aspects with unanimity. This is impossible111 .” GS112 , of the Greek Task Force pointed out decisionmaking as one of the biggest causes of the crisis. He sees the problem to be way beyond Greece. Greece could be removed from the Eurozone and problems would still exist. He considers politics as not part of the solution, but part of the problem. Politicians keep attempting to push back the hard choices into the future and the longer this continues, the higher the costs. “This has been true not 109 Ahearne, Schmitz, Von Hagen: Current Account Imbalances in the Euro Area. 110 Personal Interview in Brussels (See Appendix 9.4.4) 111 Personal Interview in Brussels (See Appendix 9.2.1) 112 Personal Interview in Brussels (See Appendix 9.3.4)

only for Greece but for the whole management of the EU113 .” There will come a time when the voting process will have to include less unanimity. The crisis in Greece has exposed some structural problems in the EU. As Dr. Crespy mentioned, the Eurozone has been formed throughout many treaties and at the time of the treaty, Commission officials went as far as they could to integrate countries114 . However, they knew that the project would not be complete at the time. Today, however, officials have not continued the integration project and some elements are only partially integrated.

5.6 Structural Problems in the EU The crisis reveals that there are different levels of centralization within the EU. As De Grauwe puts it, “The structural problem in the Eurozone is created by the fact that the monetary union is not embedded in a political union… [Leading] to a dynamics of creeping divergences between member states and no mechanism to correct or to alleviate it115.” As De Grauwe mentions in his article, this creates a system of divergent movements in competitiveness and leads to budgetary differences among the countries. “This lack of political integration leads to a buildup of economic and budgetary divergences leading to a crisis116.” If this is not fixed soon, the next time the Eurozone enters into a recession, this will all happen again. The problem in the long-run for Europe is a lack of cohesion on the political level. Through the interviews and literature review this theme kept coming back. The entire system was created so that the countries would not be at war with each other ever again and while there has not been a war within the nations, there has also not been agreement on the political or economic level. The countries resist expanding the European Union budget and get suspicious of each other at the Commission level. Fixing such a problem of a lack of integration is tough and solutions are difficult to imagine. “One is led to the conclusion that the inability to create a more intense political union in the Eurozone will continue to make the latter a fragile construction, prone to crises and great turbulence each time such a crisis must be resolved117 .” It is difficult to think of concrete solutions to promote political unity.

6. Possible Solutions The European Union’s institutions are well aware that a problem is at hand and 113 Personal Interview in Brussels (See Appendix 9.3.4) 114 Personal Interview in Brussels (See Appendix 9.2.1) 115 De Grauwe, Paul. “The Greek Crisis and the Future of the Eurozone.” 116 De Grauwe, Paul. “The Greek Crisis and the Future of the Eurozone.” 117 De Grauwe, Paul. “The Greek Crisis and the Future of the Eurozone.”

are thinking of solutions. The common theme for all these solutions is that they involve both fiscal consolidation and long-term sustainability. In this section, we enumerate a list of possible solutions and discuss their viability.

6.1 ECB Based Financial Assistance 6.1.1 European Financial Stability Facility (EFSF) The EFSF was the first sort of ECB based solution that was attempted. On May 9, 2010, the 27 EU agreed on a proposal to attempt to solve the crisis. The EFSF was aimed at preserving financial stability in Europe by providing assistance to struggling states. The Commission is allowed to borrow sums up to a total of 60 billion Euros. The Commission then used these funds to make loans to the member state in economic troubles. The benefits of such a system are that “there is no debt-servicing cost for the Union. All interest and loan principal is repaid by the beneficiary Member State by way of the Commission. The EU budget guarantees the repayment of the bonds...in case of default by the borrower118.” In its inaugural benchmark on January 25, 2011, the EFSF issued 5 billion Euros of 5-year loans. This mechanism was positively received by financial markets. Stocks surged worldwide. The facility also calmed investors and they began to believe that the Greek crisis would not contaminate healthier states. As of today, the mechanism has been used several times. As stated by the European Commission, “The EFSM has been activated for Ireland and Portugal, for a total amount up to 48.5 billion Euros (22.5 billion for Ireland and up to 26 billion for Portugal) to be disbursed over 3 years (2011-2013)119 .” 6.1.2 European Financial Stabilization Mechanism (EFSM) On January 5, 2011, the EU created the EFSM that was to serve as an emergency funding program aimed at preserving financial stability for member states in economic difficulty. This fund has the authority to borrow up to 60 billion Euros120 . “The EFSM has been activated for Ireland and Portugal, for a total amount up to 48.5 billion Euros, to be disbursed over 3 years (2011-2013)121 .” This program was later replaced by the European Stability Mechanism. 118 European Financial Stabilisation Mechanism (EFSM)-European Commission http://ec.europa.eu/economy_finance/eu_borrower/efsm/index_en.htm 119 European Financial Stabilisation Mechanism (EFSM)-European Commission http://ec.europa.eu/economy_finance/eu_borrower/efsm/index_en.htm 120 European Financial Stabilization Mechanism-European Commission 121 European Financial Stabilization Mechanism-European Commission

6.1.3 European Stability Mechanism (ESM) In light of the continued sovereign problems, policymakers decided to install a permanent mechanism, which provides financial support to be able to support member states that are threatened regarding financial instability and potentially threaten the entire EU. The Treaty Establishing the European Stability Mechanism122 was signed on October 8, 2012, after being ratified by the Member States. The ESM is considered the primary support mechanism to the Member States. The ESM differs from the ESM slightly. “The ESM will issue bonds or other debt instruments on the financial markets to raise capital to provide assistance to Member States. Unlike the EFSF, which was based upon euro area Member State guarantees, the ESM will have total subscribed capital of €700 billion provided by euro area Member States. €80 billion of this will be in the form of paid-in capital with the remaining €620 billion as callable capital. This subscribed capital will provide a lending capacity for the ESM of €500 billion123.” Financial aid from the ESM will come after a Member State requests the Chairperson of the ESM’s Board of Governors and will be provided conditionally dependent upon the mechanism requested. The mechanisms available under the ESM are based upon those, which were allowed under the EFSF. These are providing loans to Member States in difficulty, intervening in primary and secondary markets in debt, and provide loans to governments to recapitalize financial institutions. The plan with the ESM was for it to be able to react more quickly because of its robust capital and enhance governance structure. Additionally, “It will be more insulated from the rating migration of Member States; and assistance provided by the ESM will not be rerouted to Member States in public finance statistics124.” 6.1.4 ECB Backed European Bonds Another plan that has been proposed is that of Eurobonds. Eurobonds are bonds that are not denominated in a single country’s currency. It is a tool that has been proposed to attempt to get a handle on the debt situation in some of the weaker countries. A bond issued by the Eurozone, the Eurobond, “could help some of its weaker members, as investors might be more willing to buy bonds from the entire 122 The Treaty Establishing the European Stability Mechanism http://europa.eu/rapid/pressrelease_DOC-12-3_en.htm 123 European Stability Mechanism (ESM)-European Commission. http://ec.europa.eu/economy_finance/european_stabilisation_actions/esm/index_en.htm 124 European Stability Mechanism (ESM)-European Commission. http://ec.europa.eu/economy_finance/european_stabilisation_actions/esm/index_en.htm

region rather than, say, Italy, or Spain125.” A joint Eurobond would be a way to enable the weaker countries to receive some benefits from being associated with the stronger countries and would further integrate the region fiscally. There are two main ways that the bonds would start. One option would be to “integrate the current stock of debt and issue common debt126 .” The other option would “involve a debt redemption fund and some sharing of fiscal policy127 .” All of the countries in the Eurozone would issue debt collectively and accept joint liabilities for outstanding debt. The difficulty would be for countries such as Germany and the Netherlands, which might “resent lending their own country’s credit rating to less-disciplined problem countries like Spain or Italy128.” However, with rising debt issues in some countries, Eurobonds will have to be considered as a solution. Billionaire investor, Soros stated in an interview with Spiegel that Germany would either have to accept the idea of Eurobonds or leave the union, proving how important of an idea this is to him129. Soros “urged Germany to agree to the establishment of the European Stability Mechanism, calling on the country to ‘lead or leave.’ Now he says that Germany should exit the euro if it continues to block the introduction of Eurobonds130.” 6.1.5 Evaluations Clearly, ECB financial assistance is a reality as several large packages have already been put into place. The advantage of using the ECB financial assistance to deal with the crisis is that it keeps the Eurozone together and stabilizes the financial system in the short-run. However, these solutions create unsecured liabilities for the ECB and can indirectly jeopardize the long-run health of the current high-performing Eurozone members. So far, Graph 21 shows that the ECB has already committed individually almost $500 billion, not including IMF contributions and the funds established above. In addition, the total price tag of an ECB-based financial assistance program is yet to be determined and it could be quite high. An independent study by noble prizewinner Robert Engle of NYU Stern Systematic Risk Rankings finds that the complete cost of all of the necessary ECB-based financial assistance programs to be $2 trillion. This is a large amount of financing. The problem would be that, at this point in time, this would potentially have to be written by Germany, which “would more than double outstanding German debt and burden taxpayers for generations131.” 125 Boyle, Catherine. What Exactly Is a ‘Eurobond’ Anyway? 126 Boyle, Catherine. What Exactly Is a ‘Eurobond’ Anyway? 127 Boyle, Catherine. What Exactly Is a ‘Eurobond’ Anyway? 128 Sizemore, Charles. Eurobonds: What Are They And Why Do They Matter. 129 Interview conducted by Gregor Peter Schmitz and Thomas Schulz for Spiegel. 130 Sinn, Hans-Werner. Should Germany Exit the Euro? Project Syndicate. 131 Eurobonds Can Save Europe’s Banks. Engle, Robert.

The problem is in finding this money. One option Engle suggests is “by committing to back Eurobonds or similar forms of debt mutualization. If $2 trillion of Eurobonds were authorized to recapitalize the banks-and the first tranches sold and used to rescue the weakest banks-then confidence in the market would do the rest132.” Engle stipulates that this would be a good investment because investors would buy preferred shares and warrants and if the banks survive would pay off incredibly well. The hard part of implementing such a costly plan would be convincing Germany to support it. However, Engle states that the costs of such a plan would be zero. He comes to this conclusion by saying “Eurobonds sold to investors would pay interest, of which Germany will need to contribute its share over the long term. However, the interest rate on these bonds will be well below the rate paid by the banks receiving capital injections. If these banks survive, then their interest payments will cover the cost of Germany’s interest payments.” If his conclusion is accurate, then such a plan is viable.

6.2 Banking Union The idea of a banking union has been proposed as a solution for solving the Eurozone crisis. Banking Union has several elements described below. 6.2.1 Placing Eurozone Banks under the Supervision of the ECB This criterion is the first one we will speak about because it has already started to be implemented. In September of 2012, The European Commission proposed a package for banking supervision in the Eurozone. This package contained “a legislative proposal for a Council Regulation to give specific tasks related to financial stability and banking supervision to the European Central Bank, the establishment of the European Banking Authority to the modified framework for banking supervision, and a communication outlining the Commission's overall vision for the banking union133.” In Brussels, in December of 2012, European leaders finally agreed that some sort of banking union is necessary and started making viable steps towards it. European policymakers agreed that 100-200 large banks in the Eurozone would fall under the direct supervision of the European Central Bank. Many of the smaller banks would still be supervised by national regulators. As President Francois Holland of France said, “It’s a good day for Europe. The crisis came from the banks, and mechanisms have been put in place that will mean nothing is as it was before134.” The initiative by the leaders still had to be approved by Parliament. 132 Eurobonds Can Save Europe’s Banks. Engle, Robert. 133 Commission Proposes a Package for Banking Supervision in the Eurozone. 12/09/2012 134 European Leaders Hail Accord on banking Supervision

This agreement was welcomed by the Members of the European Parliament on March 19, 2013. “German Green MEP Sven Giegold said the agreement would lead to greater democratic accountability, as the parliament will now have a greater say than originally planned in appointing the chair of the supervisory board135.” A huge advantage of this agreement is that the European Stability Mechanism, the Eurozone’s permanent bailout fund, can now directly help struggling banks rather than working through national supervisors. Through this crisis it has become apparent that having different supervisors for the many aspects relating to banks is inefficient and cumbersome. Having one single supervisor, the European Central Bank, will promote economic efficiency. The ECB will have to have a single rulebook to apply to all banks under its supervision and it will be the sole supervisory body. Finance Ministers from the European Union’s 27 countries have agreed to appoint the ECB as the single regulator for the biggest banks in the Eurozone in December of 2012136. 6.2.2 Creation of a Bank Resolution Scheme In June of 2012, The European Commission issued a memo on a bank recovery and resolution proposal stating the necessity and urgency of this addition to a banking union. This aspect is necessary because the crisis has seen a large amount of banks that have failed, forcing state support to rise to unprecedented levels. Using public funds for such bailouts is becoming unsustainable so it is necessary for there to be a system set in place for government bailouts to go about in a smoother way. The move towards a unified bank resolution scheme is “an integral element of the banking union, which must have a resolution authority to close or restructure banks whenever appropriate. Again, it is not sufficient that banks operate in an environment only with somewhat harmonized rules about bank resolution. It is necessary that there is a legal framework that clearly and unequivocally specifies rules and procedures in case of a bank resolution” (Vitor Constancio, VicePresident of the ECB)137. The design of such a system is a political decision, which will take some time to sort out. However, European policymakers are becoming more aware of the need of this aspect as well and making strides towards adding this component as well.

135 BBC: MEPs welcome new agreement on Eurozone banking supervision 136 Financial Times: Long road to a single EU bank regulator 137 Taken from a lecture held at the start of the academic year of the Duisenberg School of Finance, Amsterdam, 7 September 2012

6.2.3 Common Deposit Scheme As stated by the EU Single Market on Deposit Guarantee Schemes, “Deposit Guarantee Schemes reimburse a limited amount of deposits to depositors whose bank has failed. From the depositors’ point of view, this protects a part of their wealth from bank failures. From a financial stability perspective, this promise prevents depositors from making panic withdrawals from their bank thereby preventing severe economic consequences.138” On July 10, 2012, the Commission adopted a legislative proposal for a thorough revision of the Directive on Deposit Guarantee Schemes. This topic has recently been touched upon in relation to issues in Cyprus. On March 16, 2013, finance ministers reached an agreement to “force depositors at Cypriot banks, including those with less than 100,000 Euros to share in the cost of the latest euro-area bailout139.” This does not seem to be a move in the right direction for this aspect of banking union. As Roberto Henriques, an analyst at JPMorgan Chase in London wrote, “This will be the death knell for an EU Common Deposit Guarantee scheme. With this action, one of the stabilizing instruments will have been completely undermined in the current process and, in the future, we may see a very strong reaction in deposit flows in the event that a banking sector may experience stress140.” 6.2.4 Evaluations Hans-Werner Sinn, a professor of Economics and Public Finance, University of Munich and Harald Hau, a professor of Economics and Finance at the University of Geneva provides insight on why the systems proposed currently are flawed. First, “the write-off losses imposed on taxpayers would destabilize the sound countries.” In this situation, the financial burden would shift from the shareholders to the taxpayers of the high performing countries. Imposing these burdens would “stoke existing resentments141.” Additionally, “asset ownership in bank equity and bank debt tends to be extremely concentrated among the richest households142 .” While there are flaws in the systems being currently proposed, Sinn concludes by stating “A centralized supervision and resolution authority is 138 The EU Single Market: Deposit Guarantee Schemes 139 Bloomberg: Cyprus Bank Tax Threatens European Deposit Guarantees Plan 140 Bloomberg: Cyprus Bank Tax Threatens European Deposit Guarantees Plan 141 Sinn and Hau. CESifo Group Munich-Ifo Viewpoint No. 143: The Eurozone’s banking union is deeply flawed. Published under the title “Die gefährliche Dimension der Bankenunion”, Frankfurter Allgemeine Zeitung, No. 18, 22 January 2013, p. 13 and in an abridged under the title “The eurozone’s banking union is deeply flawed”, Financial Times, 29 January 2013, p. 9. 142 Sinn and Hau. CESifo Group Munich-Ifo Viewpoint No. 143: The Eurozone’s banking union is deeply flawed. Published under the title “Die gefährliche Dimension der Bankenunion”, Frankfurter Allgemeine Zeitung, No. 18, 22 January 2013, p. 13 and in an abridged under the title “The eurozone’s banking union is deeply flawed”, Financial Times, 29 January 2013, p. 9.

necessary to address the European banking crisis143.” Currently, the ECB has large unsecured debts and with a banking union, it can secure them. For this to be done most effectively, “bank resolution should be subject to binding rules for shareholder wipeout and creditor bail-ins if a decline in the market value of a bank’s assets consumes the equity capital or more144.” In the systems currently being proposed, Europe runs the risk of undertaking even more debt which would create “a decade of economic decline145.”

6.3 Excluding Weak Nations From the Eurozone Another solution to the crisis has been the call for Greece and other peripheral countries to leave the Eurozone. This solution is definitely complex. It would entail removing a nation from the Eurozone and thus returning it to its old currency. Its exchange rate would have to be adjusted and it would potentially default on its debts with the ECB and other foreign creditors who would take a huge loss. One thing that would have to be decided is whether the external debt of the independent country would be in Euros or in the new local currency. This solution has several short and long-run implications for both the country leaving as well as the remaining Eurozone countries. 6.3.1 The Case of Greece and Cyprus Greece is often mentioned as a country, which remains, on the brink of staying in the Eurozone. Many cite the crisis of Europe as a crisis of Greece. The ECB is faced with the option of encouraging a Greek exit or continuing to support the nation. However, doing so proves that the ECB will not punish bad governance and will continue to support struggling economies. This might detract from the European integration project on a political level. The other option is “letting Greece default on the banking system and macroeconomic policies in the Eurozone146.” We interviewed members of the Greek Task Force at the European Commission. Greece is currently entering into its third program of bailouts. The first two have not worked. Greece’s case is unique because the 143 Sinn and Hau. CESifo Group Munich-Ifo Viewpoint No. 143: The Eurozone’s banking union is deeply flawed. Published under the title “Die gefährliche Dimension der Bankenunion”, Frankfurter Allgemeine Zeitung, No. 18, 22 January 2013, p. 13 and in an abridged under the title “The eurozone’s banking union is deeply flawed”, Financial Times, 29 January 2013, p. 9. 144 Sinn and Hau. CESifo Group Munich-Ifo Viewpoint No. 143: The Eurozone’s banking union is deeply flawed. Published under the title “Die gefährliche Dimension der Bankenunion”, Frankfurter Allgemeine Zeitung, No. 18, 22 January 2013, p. 13 and in an abridged under the title “The eurozone’s banking union is deeply flawed”, Financial Times, 29 January 2013, p. 9. 145 Sinn and Hau. CESifo Group Munich-Ifo Viewpoint No. 143: The Eurozone’s banking union is deeply flawed. Published under the title “Die gefährliche Dimension der Bankenunion”, Frankfurter Allgemeine Zeitung, No. 18, 22 January 2013, p. 13 and in an abridged under the title “The eurozone’s banking union is deeply flawed”, Financial Times, 29 January 2013, p. 9. 146 De Grauwe, Paul. “The Greek Crisis and the Future of the Eurozone.”

country is not really a modern state. Public administration is in poor shape. “Overhauling a state bureaucracy which has been inefficient for centuries takes time147 .” Fully integrating Greece into Europe and making it a modern state could be difficult. While Greece is often cited as the country most likely to exit the Eurozone, in reality studies are showing that Cyprus might be the first. Paul Krugman offers a compelling argument stating that Cyprus should leave the Eurozone148. Cyprus is about to enter depression, which will last for many years while it is trying to create an export sector. Krugman states, “Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding149 .” The main exports of Cyprus are banking services and tourism and banking is no longer as strong as it used to be. The creditors are demanding massive austerity measures to provide the loans Cyprus needs and with these Krugman estimates a 20% fall in real GDP. He argues that to prevent this depression, Cyprus needs a tourist boom and a growth of other exports. The main way to achieve this is through devaluation, which is not possible in the Eurozone. In contrast to Greece, where the majority of people have expressed a desire to stay within the Eurozone, many Cypriots prefer leaving the Eurozone making an exit of Cyprus more likely. 6.3.2 Short-‐Run Impact In these next two sections, we specifically look at the case of Greece as an example of what the short-run and long-run impact for a typical small country exiting the Eurozone would be. Excluding weak nations would create many issues, the most important of which is contagion. “A Greek departure from the euro could trigger a default-inducing surge in bond yields, capital flight that might spread to other indebted states and result in a series of bank runs150.” Investors would question which country would be the next to be excluded and as fear rises, investors will move money out of weaker nations. “Although Greece accounts for 2 percent of the euro-area’s economic output, its exit would fragment a system of monetary union designed to be irreversible and might cause investors to raise the threat of withdrawal by other states151.” Liabilities will rise in countries such as Spain and Italy almost immediately as investors move their money to more stable states such as Germany. The ECB would be forced to create mechanisms, which would promote stability and keep the banks from other weak nations from collapsing. If the EU is not able to create solutions, which seemingly protect other weak nations, the entire euro could collapse. 147 Personal Interview in Brussels (See Appendix 9.3.4) 148 Krugman, Paul. Cyprus, Seriously. NYTimes 149 Krugman, Paul. Cyprus, Seriously. NYTimes 150 Bloomberg: Euro Officials Begin to Weigh Greek Exit as Euro Weakens. 151 Bloomberg: Euro Officials Begin to Weigh Greek Exit as Euro Weakens.

Additionally, the Greek population would view upon such a solution unfavorably. Mr. Pangalos stated that if such a decision is made, “we will be in wild bankruptcy, out of control bankruptcy. The state will not be able to pay salaries and pensions. This is not recognized by citizens152.” A return to the drachma “would be a nightmare. It would create a panic for businesses and also for people wanting to do business with Greece153.” 6.3.3 Long-‐Run Impact In the long-run, an exit may be quite beneficial for the country that left because it can use exchange rate mechanisms. In the long run, the country can have a devalued currency so stronger competitiveness. If the external debt were in the local currency, it would be much devalued so it gets rid of its external debt. It thus has a chance of economic growth. The country also regains monetary policy so is better able to fight recessions. There is also impact for the European Union. In the long-run, recession will have run its course therefore the weak members will have left and whichever ones remain will be the countries that should stay in the union. The remaining countries in the Eurozone should be members of a stronger and healthier union as a result of the exit of the weaker members. Depending on what happens on the external debt, the debt could however hurt the countries left in the union but the benefits from being stronger as a result of the exit of the weak members overshadows this loss. In the longrun, there are many benefits to both the Eurozone and the exiting country. 6.3.4 Evaluations Some leaders have called for Greece to be kicked out of the Eurozone. However, according to the experts we interviewed and many articles written on the topic, the exclusion of weak Eurozone countries appears not to be a viable option at the moment. This is because the risks of the contagion affects triggered by a country leaving appear to be higher than the potential gains from such an exit.

6.4 Common Fiscal Authority 6.4.1 The Concept of a Fiscal European Union Fiscal union is the fiscal integration of a group of states. In such a union, each nation is asked to give up its fiscal authority. It has been proposed that the Eurozone should adopt fiscal union. This would imply that all taxes are collected by one common institution, which also determines how to spend the revenues. 152 The Telegraph: Greece will run out of money soon, warns deputy prime minister. 153 New York Times: Greek Businesses Fear Possible Return to Drachma.

This would ease fiscal aid because all of the money would be coming from the same place. It could allow greater transparency because all of the accounts would be united. It would prevent individual countries from running unreasonably large deficits and debts. Out of the many interviews we conducted in Europe, all of the interviewees mentioned that fiscal union will be necessary to prevent further crises. As Dr. Brzeski of ING stated, “If the Eurozone wants to survive, the ultimate solution is to have more Europe independent institutions with far-reaching powers154 .” A similar sentiment was felt in the interview with Dr. Zarvas155, the chief economist of European Policy Centre Think Tank. He stated that the current level of integration is not enough and that fiscal union is necessary156. He mentioned, “Some form of fiscal union is essential157.” He stated many benefits to fiscal union. Interest rates would decrease so costs of financing would decrease. It would help deal with the debt issue because debt would be mutualized. The big concern many of the interviewees cited was the difficulty of creating this fiscal union. Dr. Campos of IESE mentioned that if such a system were created now, there would be clear winners and losers, making it difficult politically to create fiscal union158 . Additionally, Dr. Darvas stated, “mutualization of debt can only happen if there are mechanisms to deal with the disciplinary issue159 .” If all the nations will unite fiscally, some measures for discipline must be put in place to sell this idea politically. 6.4.2 Evaluations When the EU established the European Central Bank, the nations that joined the Eurozone gave up monetary policy. Common fiscal policy would then be the next step for achieving fiscal consolidation. The problem with creating increased centralism will not be whether this is possible, but if it is done effectively. Dr. GS compared this process to building a house160. You cannot build a few pieces at a time in this case, but rather European officials will have to start with a plan and an architect and start from the foundation. Improvisation will not work in this case. It will take a synchronized approach between all the actors. “There is no doubt that more integration is needed but doing it slowly has worked in the past, but in this case it won’t be enough161 .” 154 Personal interview in Brussels (See Appendix 9.1.2) 155 Personal Interview in Brussels (See Appendix 9.4.2) 156 Personal interview in Brussels (See Appendix 9.4.2) 157 Personal interview in Brussels (See Appendix 9.4.2) 158 Personal Interview in Brussels (See Appendix 9.1.2) 159 Personal interview in Brussels (See Appendix 9.4.2) 160 Personal Interview in Brussels (See Appendix 9.3.4) 161 Personal Interview in Brussels (See Appendix 9.3.4)

A common fiscal authority clearly emerges as a step in the future, which will have to be taken in the future to achieve financial stability. However, whether EU member countries will ever be ready to give up that amount of sovereignty is the real issue. Dr. Zuleeg stated that this is not where the discussion is going at the European level162 . Policymakers are instead talking about ways of making the current setup work. However, looking at the issue on economic terms, monetary union without fiscal union is incredibly problematic. It can be argued that issuing Eurobonds and creating a full banking union are steps towards a common fiscal union. However, for a real fiscal union, political union will have to be much greater.

7. Conclusions In this paper, we have discussed several explanations to the current Eurozone crisis as well as some possible solutions for the crisis. The causes we discussed were exceptions of the standards for new members, non-adherence to standards by existing members, violations of optimal currency rules, and current account imbalances. Of those explanations, we find that the exceptions of standards for new members and the non-adherence to standards by existing members are the most significant causes of the crisis. We also discussed a number of solutions that may solve the crisis. In particular, we discussed ECB-based financial assistance including issuing Eurobonds, the establishment of a banking union, the exclusion of weak nations, and the formation of a common fiscal authority163. Some of these solutions have already been implemented. In particular, a number of ECB-based financial assistance programs. Furthermore, elements of a future banking union are in the implementation state. The exclusion of weak nations has been discussed, in particular in the context for Greece and Cyprus. Of those two, only the exit of Cyprus appears to be likely at this point. The establishment of a common fiscal authority appears to be the most elusive solution, hindered by the complexity of the European political process. On one hand, the measures to contain the crisis that have already been implemented have been successful in avoiding a financial meltdown and subsequent economic collapse of the weak Eurozone members. On the other hand, they have failed to restart the growth process in the weak Eurozone members. Quite on the contrary, the weak nations seem to be mired in a 162 Personal Interview in Brussels (See Appendix 9.4.4) 163 Excluding strong nations, as suggested by Soros, has not been discussed.

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economic trap of high debt and deficit, high unemployment (in particular among the young), and low economic growth. However, it may be too much to expect that short-term financial assistance programs can replace the long-term structural reforms needed in the weak countries to restore economic growth and prosperity.

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8.3 List of interviews Mr. Jean Gabriel Arqueros, Societe Generale Switzerland Mr. Roberto Barrera, Mexican Ministry of Economics’ Mission to the EU PB, European Commission Dr. Carsten Brzeski, ING Bank Dr. Rolf Campos, IESE Business School Dr. Amandine Crespy, ULB University Dr. Zsolt Darvas, Bruegel Think Tank Dr. Robert Gassler, VUB University HG, European Commission Mr. Luis Gonzalez, Mexican Ministry of Economics’ Mission to the EU Dr. Michel Huysseune, ULB University Dr. Jean-Victor Louise, ULB University Dr. Bert Mosselmans, VUB University Dr. GS, European Commission Mr. Miguel Vanegas, Mexican Ministry of Economics’ Mission to the EU Dr. PW, European Commission Dr. Fabian Zuleeg, European Policy Centre Think Tank

9. Appendix 9.1 Interviews: Academia-‐Economics 9.1.1 Dr. Carsten Brzeski Interview with Carsten Brzeski-Senior Economist and Vice-President of ING Bio: Carsten Brzeski is a Senior Economist and Vice-President of ING Bank Belgium in Brussels. He is originally German and has worked as an economist at the European Commission and other posts in international economics. “Broad international background in economics and finance, combining public and private sector experience in economic analysis and policy-making. Main focus and expertise on macroeconomic developments in the Eurozone and Germany, ECB watching, monetary policy, exchange rate and interest rate developments and financial market developments.”-LinkedIn Profile Location: Interview occurred at ING Bank in a common room. Time: Interview was at 10 a.m. Date: July 24, 2012 Type of interview: In person question and answer.

JP: The European Commission set up a list of criteria termed the convergence criteria to enter the Eurozone but after doing some readings, it seems as though few countries actually obeyed the criteria. Could adherence to the criteria have helped the EU escape the crisis it is currently in and are those criteria still relevant for other nations? CB: Debt criteria are not very relevant now. When countries were applying to enter the Eurozone, they changed the debt level so that they had a significant reduction of their debt. That was for Belgium, Italy, and for Greece especially. They would not have qualified now. Now we are noticing that even if their debt level was 100 percent of GDP, they assumed that their fiscal deficit would remain within the limits and if they have growth or inflation. There was some improvement in adherence to the laws at the beginning, but it quickly stagnated. If they had applied the criteria very strictly there would have been a smaller Eurozone but more stable Eurozone. I think that the Eurozone will shrink but now in a much more disorderly way than if it had been more controlled at the beginning. That would be leaving the Eurozone and the chaos would be much stronger than if it was at 1998. Instead of 11 countries, they should have just done 8.

JP: Oftentimes it seems as through the Eurozone is not economically beneficial to nations. Do you agree? CB: The Eurozone has already been a combination of politics and economics. At this point, if you take a country like Greece, it is hard to see how it would perform with its own currency. If they have their own currency they can devalue it but in the case of Greece, they don’t have an export sector, which means that even if they had their own currency, the only thing they can do is increase tourism. Then you would immediately see the downside of having their own currency because of import inflation.

JP: What would happen if Greece leaves the Eurozone? CB: If Greece leaves, there would be chaos in the streets and probably a bank run, where everyone is hoarding cash. You would still have high unemployment. You would still have a fiscal deficit. The country would immediately go bust. Economically, there would be high unemployment and anarchy on the streets. No real boosts to growth. In Germany there are tourism organizations that are offering 50% reduces. Apparently it’s not enough. Greece doesn’t produce enough itself so needs to import energy and food and those prices will go through the roof. You can imagine a situation like you had in North Africa and the Middle East. Defragmenting the Eurozone will come at a high cost.

JP: Would Greece leaving negatively impact the Eurozone? CB: For the Eurozone, economically if Greece were to leave it wouldn’t make much of a difference. It’s a small country. There could however be large indirect costs-the loans given to Greece would be gone. We still have Greek bonds used as collateral so the European Central Bank and would have to take a loss on that. At the same time, what you already do see now from the other European countries is a fear of contagion. Bond yields in other countries would go up if this lack of confidence continues. Financial markets would go crazy because Greece is gone so they’d worry about who is next. There would be bank runs on other countries. So people might withdraw their banks from Spanish banks and take it to German banks. You would have to put a lot of money on the Eurozone as a whole to fight contagion. This could be in the form of loans to handle the contagion. That is something, which will come as the price for further integration.

JP: Would these costs encourage countries to leave by themselves? CB: Direct costs and potential indirect costs could both be large which would be

very dangerous to balance. No one knows. I think that if Greece leaves, we would see more of the anti-contagion measures and other countries like German pushing for further integration. A couple of other countries might leave too. It is a political future, which Europe doesn’t want to have. Many countries don’t want to delegate responsibility from the national level to the European level. It might be that some opt to leave as well and keep their national responsibility.

JP: How does this compare to the American system? CB: In the U.S., the U.S. had Hamilton, which was the cradle of the current state of the United States. What kind of federalism does the U.S. want? Strong federal states or strong federal government? The U.S. had Hamilton at the time where there was also a fight and within a couple of days they decided which way to go. Political decision-making was done by very small elite and not in a very democratic way as it is now. That is the problem for the Eurozone because there are government leaders agreeing on something but they still have to pass their national government and convince their voters. It is a much more complicated process than in the U.S.

JP: Does Europe need one fiscal authority? CB: If the Eurozone wants to survive, the ultimate solution is to have more European independent institutions with far-reaching powers. Independent fiscal authority, bank resolution scheme that has been able to unwind banks to break the link between the governments and the banking sector as a European IMF, and something like a Euro bond for common liabilities. This would also be an ultimate step but once the political situation is set up. However, the process is extremely cumbersome.

JP: Would looking at long-term benefits and allowing deficits to be larger today be an option for Europe? CB: The times are over where tomorrow will be better than today. If we increase deficits right now, we hope that in the future we can grow faster to get out of debt. Overarching the crisis, we have emerging markets catching up and the issue of aging. The trend growth will be much lower and with lower trend growth it will be harder to get out of debt. To postpone and postpone to get out of debt will only make the problems worse. If you look from the start of the monetary union, we always say that it is not the good time and we still need to invest some more and now we see where it brought us. There is always a bad time for the austerity

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measures.

JP: What happened then in the southern countries? CB: If you look at the economic problems in southern countries, they are structural problems. There were bubbles, which burst. Housing market bubbles. You can only smooth the adjustment process but not fix it.

JP: Can the countries be incentivized by the ECB? CB: If you look in the U.S., there have been lots of stimulus mechanisms. The housing market is at best stabilizing so that is a good example that this recipe does not work. Another problem in Europe is the lack of competitiveness. They have to reform their countries to find new oriented sectors to create growth. Maybe the government can provide incentives to invest in energy initiatives. But just to do it with good old fiscal spending will not do the trick because you really cannot do it so the government can help but will not completely stimulate the process.

JP: Can Europe be termed an Optimal Currency Area? CB: It cannot. We see huge divergence across the countries. The major issue is the absence of labor mobility. We have capital mobility but not labor mobility. The structures of the economies are very different. Germany has a more export driven economy and Greece and Spain are more domestically driven. Some countries are more service driven and some more export driven. However, there is huge variability within the models. And if you look in the States there are also huge changes. There is New York vs. Midwest. You can have different economic structures but you need labor mobility. That could make a difference.

JP: How could labor mobility help a country with huge unemployment rates such as Spain? CB: This would really help Spain. But there is a lack of language. Even if you speak the same language, there are still differences of culture. Here people really look back at rich national histories. There are centuries of old history. If you think on these terms, it will take a long while before you can form anything like a European identity. It will never be in place of a national identity. It can only be next or on top of it.

JP: Do you see any Europeans moving from Spain to other countries? CB: You do see some of these trends. You see some Spanish people going to Germany. However, it is mostly the very low educated or high educated. Lowdon’t need the language and the highly educated speak other languages and have very specialized skills so can get a job anywhere.

JP: Are the austerity programs working currently? CB: They are undermined by the recessions so you need to make a distinction. Most are a combination of a quick fix like increase of VAT rates and a more structural adjustment like lowering unemployment benefits. That’s the combination of course that right now you don’t see it in the public finance numbers but hopefully you see it in a couple of years in structural changes in the economies. The adjustment simply requires time and you can only buy this time by bailout money or intervention by the European Central Bank. If you implement austerity programs, it will choke off growth but you hope that if you continue, at some point in time (we saw it in Germany), if it is a structural change or reducing subsidies, after a while you really see that the economy picks up a while based on the structural changes. But for that to happen it’s still too early.

JP: Thank you very much for your time. It has been a pleasure to hear your comments and learn more about this complex issue. I thank you for your help in answering these questions.

CB: The pleasure is mine. I wish you all the best and let me know if you have any further questions.

JP: Thanks again. Have a great rest of the day.

9.1.2 Dr. Rolf Campos Interview with Dr. Rolf Campos-Professor of IESE Business School Bio: Rolf Campos is assistant professor in the Department of Economics. He earned his Ph.D. and M.A. in economics at the University of California Los Angeles. He also holds an undergraduate degree in economics at the Universidad Católica Argentina and completed his graduate studies in economics at Universidad Torcuato di Tella. His areas of specialization include financial economics, banking, macroeconomics and applied economic theory. Location: IESE Business School in Madrid, Spain Date: December 19, 2012 Time: Interview was from 11:03 p.m.-12:00 p.m. Type of Interview: In person, question and answer JP: Could you tell me about your projects and research interests? RC: I work primarily in financial economics/banking and on the other side I look at how unemployment affects consumption.

JP: Can you tell me about the current unemployment situation in Spain? RC: Now, we have record unemployment. GDP dropped less in respect to the drop observed in Germany but where Spain differs is in unemployment. Unemployment here is about at 25% of the labor force. There has been a huge destruction of unemployment here. This also happened in Greece.

JP: Why has unemployment hit Spain so hard? RC: In Spain, before we had this recession, we had a real estate and construction bubble. Then once the recession hit, all these people were out of a job and couldn’t switch sectors. Inside the US, this is similar to Nevada. Nevada now has one of the highest unemployment rates. Nevada also saw a huge boom from the construction bubble, which affected Spain. Main difference is that if you are unemployed in Nevada they can go to another state and speak the language and know the culture. This is not the case in Spain

JP: So language and culture can be seen as barriers to finding employment?

RC: In Europe, you have free mobility in theory but not in practice. It is not very easy to move to another region.

JP: If there was free mobility would that help? RC: It should. As long as you think that someone will move to get a better job, then it should.

JP: Are there other factors that are unique to Spain? RC: Another factor that gives you less mobility is that Spaniards are homeowners and in other countries in Europe people rent. A big faction here own homes. Then it is more difficult to move. You don’t want to sell your home in a recession. So you are forced to stay in your home

JP: Do you see that there is free mobility of capital in Europe? RC: You can move up to $50,000 Euros within the EU. If I want to send this sum to another European country, the bank cannot stop me and I am charged the same fee as if I am transferring this money nationally. It is very easy to move my account to other countries. If you look at the data, there is a capital flight from Spain. If you look at the balance of accounts in Spain, it was negative for the past few years so people are taking it from Spain and moving it to Germany or Luxembourg or Switzerland to countries, which you think, are safer than Spain.

JP: Do you think that the EU might have what it takes to be an Optimal Currency Area in the future? RC: The EU has never been one. Mostly because of the labor market. Things have been done to get closer to this optimum currency area. This works very well in capital markets because you have eliminated many barriers. In Europe, you have Erasmus, where students from one university can do a semester in another country. This helps the labor markets. You have some part of the population which is college educated. A big fraction of them have learned other languages and are more mobile than other students. For someone who works in construction, they wouldn’t have had this freedom of movement because they didn’t have this exchange experience. What we are noticing today, is that it is hard to make the current work-force more mobile.

JP: Seeing that language is an issue, do you see a migration towards Latin American countries for Spanish people? RC: Yes some people are. A lot of people are going to Brazil and Peru. People who worked in the construction sector can easily find jobs in Latin America. It is easier to move there in terms of language. But it is not so easy to find a job there because you can’t just go there and work. You need to get through all of the red tape. These are college-educated people. It is not the part of the population where unemployment is highest.

JP: Where is unemployment the highest then? RC: Highest among young people and also people with low formal education.

JP: However, I have read that some people believe that Spain would be better off out of the EU. I believe this is incorrect. What do you think? RC: If Spain had not been a part of the European Union and EMU it would have had something, which is called a balance of payments crisis. If you have money going through the financial account, if you are an individual country your foreign currency reserves will deplete. But since Spain is part of the EMU you don’t need to pay for your imports’ exchange and you can use Euros. Target 2 account what it does is that if they have more imports than exports, they can target the target 2 account and it’s not free to import but you don’t run out of foreign currency. Spain was able to use this to have a very fast adjustment of its current account. It has slowly closed. Now it is around 0 so it is balanced right now but it took like 4 years. If you had been Mexico in the year 1995 where they went from a very negative current account to a 0 account, that gives a bigger recession than what Spain has. So there are many advantages to being a part of the EMU for Spain.

JP: What are your thoughts on the austerity measures? RC: If Europe was not there you would have to do even bigger austerity measures so no one would give the money. The option is not accepting the money from the EU. If you accept the money it is because it is better than the alternative. If you compare it with not being in the EMU, Spain is better off.

JP: Do you see the EU as simply a political project?

RC: It started with the initial building up after the world war. It was a way of getting countries that were fighting world wars to never fight again and have on government for the whole of Europe. It was originally a political project but became more of an economic project. This led to introducing the euro. Some countries opted out such as Denmark and Sweden, etc. It had this political component at first and then became more and more economic. This tells something about the future. Some countries might think that since it’s not sustainable maybe I should be against it. But if it has the political component, you can realize that they will keep on trying to build it up because there are political payments to it. That is something that will happen. The euro won’t go away. Also this political dimension is quite strong.

JP: Do you think that having a monetary union without a fiscal union is impossible? RC: It makes it more difficult to have a monetary union because you have different shocks. One tool that you don’t have to respond to this is the fiscal union. If you look at the US and have a shock, then you can move resources to Nevada for example and have an expansionary economic policy in Nevada to reduce that in that state. In Europe, we don’t have that and we notice that we have bigger recessions and cycles in each region. You only have monetary policy that is overarching for the whole Region and you can’t really target the whole region. This doesn’t mean that the euro can’t survive but it just means you suffer more

JP: Do you think that there is a chance for Europe to become a fiscal union in the future? RC: Europe will move towards something closer to a fiscal union. But if you want to do it right now, there would be winners and losers. You have periphery countries in recession and core countries not in recession. If you start right now then it will be the countries that are the central ones who will pay the costs. It is difficult politically to sell this. Ideally, it is best to set this up in a time of prosperity because you don’t know who will get the money. It’s more like an insurance. You can’t buy insurance when you have already crashed. Right now we have some crashed and the insurance company will tell us to fix our cars and afterwards we will set up an insurance policy.

JP: What are of the possible causes for the crisis? Could it be that the integration process was too large?

RC: No. Most economists who looked at this in the 90s, they noticed that it wasn’t going to work because it’s not an OCA. And very soon very fast we will have trouble and break down. But it is almost a miracle that it took so long to break down and partly it is because of what happened in the rest of the world. We have the dot com bubble, lax monetary policy in the U.S., and this current recession. You had a situation where it was very easy to get along? I don’t think it is because it went too fast. Maybe because you had all these years where the world grew and you allowed these bubbles to develop, the fall is even bigger. Maybe it would have been beneficial if you had a recession before because the bubbles wouldn’t have been allowed to get as out of control as they did.

JP: Do you think that the Maastricht Treaty convergence criteria were useful? RC: I don’t know how useful they are. One of the rules was the 60% limit of debt over GDP ratio. If you look at Spain up to 2007, not only did they not have a fiscal deficit, they had a fiscal surplus and debt to GDP ratio was very low. Once you got to the recession, deficit increased and fiscal deficit accumulated as public debt so we were accumulating public debt. Now debt to GDP was almost 80%. It wasn’t enough even though you weren’t fulfilling the criteria of the Maastricht Treaty. You see that there was not sufficient condition for us to get out of crisis. These rules don’t assure you that you are not going to get into trouble. You should be even more conservative than the rules. Maastricht Treaty told the countries what they needed to do, but countries should have done better than the criteria required. We should be like Chile. Chile is a country that has almost no public debt. Greece had a debt to GDP ratio, which was almost 100%, and it greatly fell. If you look at the different countries that got into trouble, you have different stories. Spain and Ireland have low public debt and then Greece and Portugal, which had high public debt. Italy too. They got into trouble because of this. Spain and Ireland had real estate bubbles and once they burst, you had big unemployment and then the government has to pay more in automatic stabilizers and employment insurance. So you have a different story of how they got into trouble. It’s not just the rules weren’t followed but that they were maybe not enough.

JP: Could this have been a problem of regulation? RC: If you set up rules, you should make sure countries follow them. You shouldn’t have let any countries into the monetary union who didn’t follow the rules. From the start we were doing this. This says that in the future if they set up rules, we will allow countries to not follow them either. This is not a very good start a monetary union. I don’t know if the rules they had were the correct ones, but if they have rules, we should follow them.

JP: Does the voting process create problems? RC: It makes the whole crisis very slow. If you have a crisis you must respond quickly. If you know you need unanimity each country can extract benefits from using their veto power because some countries will achieve it. The ECB has its executive board and you don’t need unanimity. It is completely independent.

JP: Can you tell me your thoughts on the Fed mandates? RC: There are three things central banks do: Fight inflation, control banks (there to promote financial stability), and they might lower unemployment or have a growth mandate like the Fed. The ECB only fights inflation. Maybe the one that should be added is the financial stability mandate. Some say it is implicit in its mandate and the ECB is responding and is taking some measures to promote financial stability. Not sure if we want to put growth there because we have a history of that going wrong. In the US, before Paul Walker, the Fed was playing with the Philipps Curve. They were lowering unemployment and using monetary policy for this. What happened was that people responded in the economy and were anticipating what the central bank was doing. The Phillips curve was not stable. You can create high inflation. In the last years, it was doing less of the unemployment and more of the fighting inflation mandate. Not sure if you want the ECB to move towards that to where the Fed was in the 1970s. Also if you set up a system of fiscal transfers that won’t be necessary.

JP: Is the EU moving towards a fiscal transfers system? RC: The ECB was not allowed to buy bonds from countries. Now the loophole that they found is that the monetary transmission process is broken. There are different interest rates all around. For example, investors think that Greek debt is unsafe and you will charge higher interests and the interest rate in Greece will be higher since this trickles down. What Mario Dragi announced in one of his meetings/announcements is one way of fixing this monetary transmission problem is that we have to buy debt from countries where interest rates is very high. He is circumventing. Even though they are not allowed to buy public debt, they need to do it to fulfill the other part of the mission because the monetary policy channel (This MPC is broken). In Part what they are doing is by monetizing public debt.

JP: Would it be better to just make this process official?

RC: It started out as a loophole but now it started as the European Central bank bailout mechanism. They can ask for a soft bailout. Instead of asking for money like Greece or Portugal the ECB can step in and buy public debt in secondary markets and this is something that was agreed upon in one of the ACOFI meetings where the finance ministers meet. This is an official program. Started out as a loophole but now is legalized.

JP: Should there be a move towards more federalism? RC: If there were more federalism, you would move towards the OCA and the answer is yes. There is a need. If you don’t want much suffering, you don’t want something like this. You will have regions, which are very volatile. You will have regions with long and volatile recessions if this step isn’t made.

JP: Can the EU move towards that? RC: If you want to start that right now, we know where the funds will flow. Some winners and losers and it is politically unfeasible right now. We should have thought this when all countries were growing. We didn’t know which country was going to get into trouble first but now we know.

JP: Are countries getting antagonistic towards the EU? RC: In the case of Spain, not really. EU has surveys on EU and euro. You can see country by country how countries approve this. If you look at the case of Spain you see that they like the euro and want it to stay here and that the EU is doing their job well. In Greece, the faith that you had in European institutions has evaporated. Also in Spain people are not very knowledgeable on what happens in Europe. Some countries require a referendum to approve all EU treaties. In Spain this is not the case. This means that a lot of people simply don’t know what is happening on the European level. This is very different from Ireland. You have referendums so people are more knowledgeable.

JP: Is it good for the ECB to be independent? RC: That is part of being an independent central bank. If you are the ECB, you don’t want the government to interfere. In the past, if the president could interfere with the central bank, you saw that in those countries you had higher inflation so you wanted an independent central bank to lower inflation. People

who decide on this will be somewhat autonomous. This doesn’t mean you are unaccountable. You should give them a clear mandate and if you don’t satisfy the mandate, you are out of a job. Bernanke needs to be reappointed. If he didn’t do his job, then they will change him for some other person. You don’t want these votes to be every year because then you lose independence because he will be thinking of what the senate will think about his decisions tomorrow when he needs to be reappointed. It is an indirect election. People vote for their senators and then they vote for their Fed Chairman.

JP: Thank you very much for your time and help. RC: You are welcome. Good luck.

9.1.3 Dr. Robert Gassler Interview with Dr. Robert Gassler, Professor at the VUB in Economics Bio: Dr. Gassler is a native of Texas but has been living in Europe for quite some time teaching at the Vesalius College part of the Vrije Universiteit Brussels. He teaches Intermediate Microeconomic Theory, International Political Economy, research capstone courses, and Economics of the European Union. His relevant research interests are International Political Economy and Political and Social Economics. Location: Interview occurred at his office at the university Time: Interview was from 11:30-12:15 Date: July 10, 2012 Type of interview: In person question and answer

JP: Why were the convergence criteria ignored? RG: They realized deep down that they were stupid. They had to make sure that inflation was going at the same speed so they could lock down inflation rates. But, the criteria cut the rate of growth of the money supply, cut deficit, cut debt-toGDP ratio. And then they realized that the convergence criteria were slowing it down. The US reacted to stagnation by cutting inflation and Europe by cutting unemployment.

JP: Was the criteria not relevant in the long-run in changing countries’ economic systems? RG: Some people talk about how the convergence criteria is good for the longrun, but the short-run matters and in the short-run it was not relevant.

JP: Could they change have changed the criteria to still make requirements but make more relevant ones? RG: I think that their view was why change it when you can ignore it? The theory that should be applied is that of the neoliberals. The convergence criteria were as good as they could be at the time and the countries knew that the Commission wanted to expand the Eurozone and would accept them even if they did not meet the criteria.

JP: What happened to trigger the crisis? RG: The countries were all running surpluses before the recession hit. But when it hit, the countries received much less in revenues and were not prepared for it so that’s why we see the big problems we have now.

JP: Do you think that the austerity measures are doing their job of getting the Eurozone out of the recession? SG: No. Deficits don’t create recessions; they get you out of recessions if you increase the deficit.

JP: Could different tax policies help the situation? SG: Spending stimulates the economy. Tax cuts maybe help. Depends on who’s taxes. If you tax on people who are going to spend then that stimulates the economy. The tax multiplier is less than the government purchases multiplier. The tax cut first increases disposable income but part of that is saved. Tax cuts are the solution to decreasing the size of the government over time.

JP: Would having a central fiscal authority help? RG: That is the only instrument that would work. Monetary policy is like pushing on a string. It needs to work in conjunction with fiscal policy.

JP: If countries know that they need to have a common fiscal authority to be successful, why haven’t they done this yet? RG: There are too many political problems to do that. There is also the free-rider problem. There are coordination problems. Germany might feel that they don’t need a stimulus, or not as much as Greece so it would be hard to coordinate their shocks.

JP: The Eurozone often gets compared to the US. What do you see as significant differences? RG: If different regions in the US enter recessions, there are automatic stabilizers that will stimulate that region. Unemployment compensation goes up and other government mechanisms will kick in and cushion the recession in that region.

Automatic stabilizers are there to smooth the recession not promote growth. Europe doesn’t really have this. And that makes it harder for them to exit the recession. There are structural funds for different regions in Europe and presumably they could be enough but they are not big enough or automatic.

JP: Could the EU ever fully integrate seeing as the cultures among countries and their personal histories differ so much? RG: Germany’s had a Welfare State and an anti-inflation policy since the 20s. In principle, a stimulus to the whole economy can help everyone. There’s no reason why they couldn’t have a fiscal stimulus with a monetary twist, which wouldn’t be too inflationary. All they would need is coordination. Not only do you need coordination between the different fiscal policies but you also need coordination between fiscal policy and monetary policy. And it is obvious that they are not great at coordination.

JP: The European Central Bank is independent. Do you think this is a good or bad thing? RG: I agree with Milton Friedman that independent central banks are a bad idea. In US, the 12 district banks are governed by boards chosen from bankers. That’s just asking for it. If you’re a banker, you don’t like inflation. Bankers are not going to act fast enough to influence in the face of a recession and they are independent of anybody. The European Central Bank is completely independent. Once they become independent, their objective becomes fighting inflation. If the Central Bank wants to fight inflation, there is nothing you can do. They will achieve it.

JP: You have mentioned that you are very pro-deficits in a recession. Could you see inflation being a negative side effect of a policy such as this? RG: In a time when inflation is not the problem and will not be much of a side effect, it is not likely to be a problem until the economy gets closer to full employment. A great way to look at that is the Philips curve. I think that the Central Bank should have been working faster to lower interest rates and they didn’t. Number 2, lowering interest rates wouldn’t have cured the recession, but it would have been a help. Right now, they’re not wiling to do that because they’re anti-inflationary.

JP: Would it be better for fiscal policy to be governed 2/3rds or majority rule?

RG: In Europe, no one’s responsible for fiscal policy with the 27 heads of state. This is an unnecessary system that is incredibly inefficient.

JP: How does the EU relate to the US? RG: The budget for the EU is tiny first of all. Also, culturally, Europe is much more different than the US while geographically Europe is probably more diverse.

JP: What would be an ideal form of governance for the EU? RG: Ideal would be euro with coordinated fiscal policy. This is definitely possible. If they make a policy, they need to find an instrument that accomplishes this. If the one they are using doesn’t work, they should use another one. It seems as though there is a lack of creativity when it comes to policies in the EU. You need to have as many instruments at your disposal as you have policy objectives.

JP: Would you consider the EU as an Optimal Currency Area? RG: I would not. But the OCA theory can come to strange conclusions so I am not sure how applicable it can be. OCA would include southern England and parts of Flanders as working well together. However, I don’t think they would because they are so separated from each other and don’t have the same industrial inner workings. I think it makes more sense to have a large area where transaction costs are eliminated. So I think that while the EU doesn’t fit the OCA criteria, it eliminates transaction costs and greatly improves trade.

JP: Do you see the austerity programs as a good tool? RG: I don’t care about he size of the deficit. I see it as a tool to get out of the recession.

JP: Can Europe come back as an economic power? RG: It already is and I suspect that it will come out of the recession as an economic power but I worry about whether it can ever become a political power since the value that the US has in its favor is that whoever is in charge can make decisions more quickly than in Europe. The internal lag procedural-wise is much more cumbersome in the EU than in the US.

JP: You mention political objectives in the EU. What other reasons do you think there are for the Eurozone? RG: Basically, it all comes down to the fact that they want to integrate the countries to make sure they don’t go to war again.

JP: Thank you very much for your time. Your comments have helped me further understand this crisis.

9.1.4 Dr. Scott Gassler 2 Interview with Dr. Robert Gassler, Professor at the VUB in Economics Bio: Dr. Gassler is a native of Texas but has been living in Europe for quite some time teaching at the Vesalius College part of the Vrije Universiteit Brussels. He teaches Intermediate Microeconomic Theory, International Political Economy, research capstone courses, and Economics of the European Union. His relevant research interests are International Political Economy and Political and Social Economics. Location: Interview occurred at his office at the university Time: Interview was from 2:07 p.m.-3:05p.m. Date: December 14, 2012 Type of interview: In person question and answer Interview Scott Gassler, Ph.D. Vrije Universiteit Brussels

JP: Do you think that current system where there is monetary union without fiscal union is working? SG: No. Not working at all. You can’t use monetary policy to stimulate the economy. It is like pushing on a string. The Central Bank can make it easier for firms to borrow money and banks to lend but if you look at different sectors of the economy, the economy is in a recession. So are you going to ask the consumers to spend more? They can’t because they will save it. There is the paradox of thrift and pessimistic expectations. You can’t expect them to expand their spending to stimulate the economy. Businesses? There is a recession. Business won’t build new factories to stimulate the economy. They won’t just buy new equipment. That’s not the way they work. If there is a recession, they will pull back too. Businesses don’t invest because they don’t invest in a recession. You can stimulate exports but they are in a recession too, so that doesn’t work.

JP: So who’s left? SG: The government. They can cut taxes, but then there’s a zero point where the government gets zero taxes and you can’t cut them anymore. Or you can increase government purchases. There are limits to that too, but they don’t seem to be met in the US and not in this part of the world either. We can look at the reaction to the US fiscal cliff. They downgraded the US bonds because there was no solution to the budget problem.

JP: So Eurozone should have a common fiscal policy? SG: If they were able to agree jointly to stimulate the economy, then the economy will start growing again. It would be a great idea to coordinate fiscal policy among the countries because this could save the Eurozone.

JP: Could government spending create inflation? SG: We don’t need to worry about inflation right now. But in Europe this is hard because the ECB has only one mandate: to fight inflation. At least the US Federal Reserve also fights unemployment. If you really want a coordinated attack on the recession you have a fiscal expansion that is validated by the central bank, where the monetary policy is supported by the central bank. Best way to do that is to have them all sit down, but they can’t do that. If you have that, if the Central Bank is part of the government, and not independent, then you can blame them for the recession.

JP: So the Eurozone should spend more? Where will this money come from? SG: Yes. Who else is going to do this? It will come from the same places when businesses spend money. Businesses spend money they don’t have all the time. Every business around that wants to expand, spends more money than they get in. How do they get away with this? They borrow money. Otherwise they would use retained earnings. Governments have an additional way to spend money because they can just print it. That makes it easier for them to spend money than businesses. Every way of spending money has risks and side effects so you just have to weigh it. There’s nothing special about spending money through borrowing it. Real question is by seeing whether or not you’re being stupid about it. You can let your friends take tax breaks and later have a deficit you can’t pay for but nobody seems to worry about that.

JP: What is needed for the Eurozone to have a joint fiscal policy? SG: They have to convince people that the government can spend more money than they take in. They have to get rid of the Maastricht Treaty. Germans were among the first to violate it. No one follows it. You have to have a situation where the people in charge are allowed to expand at the right time. You have to make sure they coordinate.

JP: Will countries give up this large amount of sovereignty?

SG: They could pretend that they haven’t already decided to do this. They have already given up sovereignty, in the Maastricht Treaty, just in the wrong way. Maastricht Treaty tells them what policy to have. So they have basically already given it up.

JP: We have spoken about the positive effects of this. What are some negative effects of this common fiscal policy? SG: Always the problem that the Italians will push the system into permanent expansionary policy. They can misread Keynes. Keynes said the time to balance the budget is in a boom. People forgot that part, certainly in the US. In the last 60 years, the budget has been in surplus twice. Cutting taxes, and increasing spending is how you get out of a recession. People used to think that if you cut taxes, you obviously have to increase spending.

JP: So should there be some sort of accountability measures for the Eurozone? SG: There should be accountability for overall economic policy where fiscal and monetary policy is under the same politicians, which can be voted out. That may requires all sorts of changes in the European Union or it may be possible to do it under the system we have now. Certainly the Maastricht Treaty was done under the current system.

JP: Would they have to change the voting process to allow for this fiscal policy to be implemented efficiently? SG: They might have to. Requiring unanimity means that you give each country a veto and countries such as Greece do not need a veto.

JP: Iceland jailed the bankers. Should Europe also do something like this? SG: Yes. I say jail the ones that did illegal things and kick out the ones that created the recession. Not sure how that could be done but they don’t need to reward them like in the U.S. You can’t go around and say that all you did was follow the rules, when you manipulated the rules. That is not a very morally acceptable position.

JP: What about regulation?

SG: They need much stronger regulation because currently all they can give is a slap on the wrist.

JP: Thanks for your remarks today. SG: You’re welcome.

9.1.5 Dr. Jean-‐Victor Louise Interview with Dr. Jean-Victor Louis, Professor at the Universite Libre de Bruxelles Bio: Professor Université libre de Bruxelles - ULB (1971-2003); Hon. professor, ULB (2003- ); president, Institute of European Studies of the ULB (1980-1992); part time Professor, European University Institute, Florence (1998-2003); hon. degree, University of Paris II (2001); general counsel, National Bank of Belgium (1980-1998). President, Foundation Philippe Wiener- Maurice Anspach; general editor, Cahiers de droit européen; acting secretary general and member of the Board, Trans European Policy Studies Association -TEPSA, member of European Constitutional Law Network (ECLN). Many publications on European Community law, especially on institutions, external relations and Economic and Monetary Union. Location: Over the phone Time: Interview was from 9:00 p.m.-9:15.m. Date: Type of interview: Over the phone discussion. Interview was in Spanish, translated by me Text Translated by Jean Paul JP: Good evening. What is the most necessary integration aspect to conquer for the EU to exit the recession? JL: I think coming out of the recession means that while you bring order to public finances, you have to stimulate employment and legislation. This part is very difficult in the current situation because as all states are in recession, many have budget problems and a significant debt because they have little money to invest in areas that create employment. The issue is that the new industry, when reversed, does not create many jobs. Large industries that had thousands of workers are closing as in the car industry. These large companies hire suppliers for the production of sophisticated equipment. When a factory closes 4,000 jobs, about 10-12 thousand jobs are lost by companies that are around. This labor has a low amount of formation. Governments would have to invest in their training to speed them up to make more effective and for the future. The issue is very crucial in the steel mill. Mr. Mikal, an Indian gentleman living in England has all the mills in Europe and in the world and believes that in Europe, production costs are too high. They say there will be a relaunch of the principle of economy in the second half of 2013. But it could be 2014. The recession reduces tax revenues and is a vicious cycle because when the economy is not growing, fewer taxes are collected and then there is less chance of rolling over jobs for a more modern

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economy. European of course could create new projects or structures. But its citizens in the current situation are very opposed to it. People are not very happy in the recession then the reflection affects the construction of Europe. The English, Swedish, Austrian, Dutch believe that Europe cannot fund what is needed at the domestic level. To exit the recession requires an investment in research, education, and training of people who have no expertise to enable them to take up new job. It's called the flexi-securite. It is a combination of job flexibility and job security. These workers should have training that would go into another job. The big problem is that people who are unemployed do not have sufficient training to expand their use. There is an advantage to college but even for them and Spain youth, the concern is not having jobs.

JP: Do you think you would have more integration between Europe? JL: There should be but there is much populism that bases its programs on nationalism and believe that evil comes from outside and you have to protect yourself and believe that globalization competencies we import from China and India and Turkey are negative. All those countries that practice much lower wages than here. The cost of labor is lower. There are a number of people who believe that protectionism is needed. The credit rating agencies note that there are very few countries with AAA. People do not want a European budget over 1% of gross national product. They do not understand that spending at the European level can be an investment; it may be an administrative fee. But what to do is more precisely made for all challenges. It should be mentioned that the need for better education is not an end all solution. It is a medium-term solution. Structural reforms take time. The situation of monetary union requires a combination of launch the economy and make savings of public finances also because there is considerable debts. Currently pay millions in interest and that takes a lot of negativity of citizens. There are public buildings that need to be modernized and streets that are terrible but no money to finish all the restorations. Everything has been paid for with an increase in public debt and now we are paying all this. I agree with you that what should be done is act together and create borders to control people and work together.

JP: What do you think can be done with respect to banking supervision? JL: The supervision of banks has been more closely united. The first step has already been made and was to join more and the second step is the recovery of bank centralization. Deposit guarantee will be the third. The construction of Europe has been successful for now. We are waiting for the election in Spain. National elections are very important for the moment. For Merkel, not known if reelected will happen. Most likely not. Before the elections, there is some caution

because Merkel wants to avoid any decision that may alienate the German people vote but more important are the elections of the European Parliament in July 2014. It is likely that different parties will adopt programs which ask for the support of the voters and the orientation of these programs may have a view more or less European. Depends on what you want and what parties are more successful. In times of crisis, the end is the fundamental challenge people lose confidence in the traditional parties and vote for parties that are sometimes racist and certainly protectionist programs.

JP: Do you think these radical changes will be possible someday? JL: Yes. Everything is progressing slowly. More slowly than we would like but the problem is differentiation. It is difficult because the 27 countries are very different.

JP: Do you think that today countries are in the European Union sign the treaty for the succession? JL: I think many of the countries would not have signed the treaty for the succession.

JP: Thank you for your feedback. JL: You're welcome. Goodbye.

Original Text in Spanish JP: Buenas noches. Me pudiera comentar sobre qué es lo que usted ve que hace falta en la Unión Europea para salir de esta recesión? JL: Yo creo que salir de la recesión supone que al mismo tiempo que se pongan orden en las finanzas publicas hay que estimular el empleo y las legislaciones. Esta parte es muy difícil en la situación actual porque como todos los estados están en recesión, muchos tienen problemas presupuestarios y una deuda pública importante pues les queda poco dinero para invertir en materias que puedan crear empleo. El tema es de que la nueva industria, cuando se invierte, incluso si lo hospedan, no crean mucho empleo. Las grandes industrias que tenían miles de obreros están cerrando como en el sector automóvil. Estas grandes empresas tienen al rededor de ellos unas empresas proveedoras que contratan para hacer material muy sofisticado para la producción propia. Cuando cierra una fábrica de 4,000 empleos son unas 10-12 mil que pierden

empleo por las empresas que están al rededor. Esta mano de obra es poca formada. Habría que invertir en su formación para agilizarlos a hacer mas eficaces y para el porvenir. El tema es muy crucial en la fábrica de acero. El señor Mikal, que es un señor de india que vive en Inglaterra tiene todas las acerías de Europa y también en el mundo entero y considera que en Europa cuesta demasiado cara la producción. El porvenir en el plan de salir de la recesión por el momento no se ve muy caro cuando va ser. Dicen que habrá un principio de relaunch of the economy en la segunda parte de 2013. Pero también pudiera ser 2014. La recesión disminuye las recetas fiscales y es un ciclo vicioso porque cuando la economía no es fluorescente, hay menos impuestos que se recogen y entonces hay menos posibilidades de refinanciar los empleos para una economía más moderna. Claro europeo pudiera crear proyectos o nuevas estructuras. Pero sus ciudadanos en la situación actual están muy opuestos a todo. La gente no está muy feliz en la periodo de recesión entonces el reflejo afecta la construcción de europa. El ingles, el sueco, el austriaco, el holandés no creen que Europa pueda financiar lo que hace falta en el nivel domestico. Para salir de la recesión se necesita invertir en investigación, educación, y en formación de gente que no tiene especialización para permitirles ocupar nuevo empleo. Se llama la flexi-securite. Es una combinación de flexibilidad de empleo y seguridad de empleo. Estos obreros tendrían tener una formación que los dejaría entrar en otro empleo. El problema gordo es que la gente que está en desempleo no tiene formación suficiente para ampliar su empleo. Hay una ventaja para universitarios pero incluso para ellos como en España la preocupación de jóvenes es de no tener trabajos.

JP: Cree usted que serviría tener más integración entre Europa? JL: Eso debería de ser pero hay mucho populismo que basa sus programas sobre nacionalismo y consideran que lo malo viene de fuera y hay que protegerse y que la globalización cree competencias que importamos de china e india y Turquía. Todos esos países que practican salarios mucho más bajos que aquí. El costo de la mano de obra es más bajo. Hay una cierta cantidad de gente que cree que se necesita proteccionismo. Hay algunos que consideran que la solución es Europa pero para las perspectivas laterales multi-anuales de financiación se ven, se nota que los estados ricos tienen normalmente empleos. Las agencias de notación de crédito nos notan que hay muy pocos países que tienen AAA pero tienen una nota que es justa. La gente no quiere un presupuesto europeo que sobre pase el 1% del producto nacional bruto. No entienden que el gasto a nivel europeo puede ser una inversión, puede ser un gasto administrativo. Pero lo que hay que hacer es mas créditos para precisamente todos los desafíos. Hay que mencionar que decir que necesitamos mejor educación es todo no da resultado tampoco. Es una solución a medio plazo. Son reformas estructurales que toman tiempo. La situación de

unión monetaria necesita una combinación de lanzar la economía y hacer economías también de finanzas públicas porque hay deudas considerables. Pagan actualmente millones en intereses y eso toma mucha negatividad de los ciudadanos. Hay edificios públicos que necesitan ser modernizados y calles que están fatales pero no hay dinero para acabar todas están restauraciones. Todo se ha pagado con un crecimiento de la deuda pública y ahora estamos pagando todo esto. Yo estoy de acuerdo con usted de lo que se debe de ser es actuar común y considerar que hay que establecer fronteras para controlar gente y trabajar juntos.

JP: Que piensa usted que se puede hacer con respeto de la supervisión bancaria? JL: La supervisión bancaria se ha unido más. El primer paso ya se hizo y fue el de unirse más y el segundo paso será de la centralización de recuperación de bancos. Garantía de depósitos será la tercera. La construcción de Europa ha sido exitosa por el momento. Estamos esperando la elección en España. Las elecciones nacionales son muy importantes por el momento. Para Merkel no se sabe si la van a reelegir Es muy probable que no. Antes de las elecciones hay una cierta prudencia porque Merkel quiere evitar toda decisión que puede alejar el voto del pueblo alemán pero más importante todavía son las elecciones del parlamento europeo en Julio de 2014. Es probable que los diferentes partidos van a adoptar programas sobre los cuales pedirán el apoyo de los electores y con la orientación de esos programas se podrán tener una vista más o menos europeísta. Depende de que es lo que quieren los partidos y cuales tienen más éxito. En tiempo de crisis, los extremos es la forma de desafío fundamental de la población pierden confianza en los partidos tradicionales y votan para partidos que a veces tienen programas racistas o seguramente proteccionista.

JP: Cree usted que estos cambios radicales serán algún día posibles? JL: Si. Todo está progresando poco a poco. Más lentamente que quisiéramos pero el problema es la diferenciación. Es difícil porque los 27 países son muy diferentes.

JP: Cree usted que hoy en día los países que están en la unión europea firmarían el tratado para la sucesión? JL: Pienso que muchos de los países no hubieran firmado el tratado para la sucesión.

JP: Muchas gracias por sus comentarios. JL: De nada. Adios.

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9.1.6 Dr. Bert Mosselmans Interview with Dr. Bert Mosselmans-Dean of Vesalius College, VUB Bio: Dr. Bert Mosselmans is the current Dean of Vesalius College, part of Vrije Universiteit Brussels. He has his PhD in Economics and specifically researches History of Economics and History of Economic Thought. He is of Belgian nationality Location: Interview was conducted in the Dean’s Office at the VUB Date: July 24, 2012 Time: Interview was from 4:15 p.m.-4:50 p.m. Type of Interview: In person, question and answer

JP: Good afternoon Dr. Mosselmans and thank you for meeting with me this afternoon. What do you see as the biggest problem of the Eurozone? BM: The Eurozone receives its biggest downfall because it is a monetary union without fiscal union.

JP: Do you think that the Eurozone fits the criteria of an Optimal Currency Area? BM: The Eurozone wasn’t an optimal currency area to begin and is still not one. It is obvious that the European Union does not meet the requirements. The countries differ in terms of export/import driven, not a large mobility of labor, and not similarity of shocks all around. While the Eurozone may never be an Optimal Currency Area, something that could encourage further integration on an EU level would be joint fiscal policy. The Eurozone idea could only work with something as invasive as this.

JP: It seems as though the Eurozone is not completely beneficial on economic terms. Why else would it have been created? BM: The Eurozone is more of a political union. This is a little bit the idea of the entire European Union. However, there are some actual benefits to a monetary union in terms of trade and free movement. It facilitates transfers between country and pricing across the Eurozone. This is an actual benefit.

JP: What sorts of changes will need to be done for Europe to more fully integrate

and properly exit the crisis? BM: The main change and the one in most need would be a common fiscal authority.

JP: Would shrinking the Eurozone be a viable option? BM: Shrinking the Eurozone could also be an option, but it would have to be forced. The EU would lose a lot if countries were removed and the countries themselves would probably lose more. This would not be an ideal option but if it came to this, which it might, it would definitely not be anyone’s ideal option.

JP: You said that shrinking the Eurozone would not really affect the EU as a whole. What do you mean by this? BM: Well from an economic standpoint, some countries would be quite insignificant to the Eurozone if they left. Greece is only 2% of the economy of the Eurozone. However once Greece leaves, what would stop a country like Spain from leaving? And Spain is big on economic terms. While maintaining all the countries in the Eurozone, even the small ones like Greece, would be ideal it wouldn’t really cause large damage to the Eurozone as a whole.

JP: What is currently needed in some of these countries for a change to happen and for them to get back on the right track? BM: Some of these countries are lacking in domestic industries. This is a big problem for a country such as Greece and similarly for the other countries in their situation. The real question is whether the domestic industries are strong enough to start a recovery.

JP: How does the Eurozone relate to the American crisis? BM: The Eurozone crisis and the American crisis are both based from overspending financed by huge debts. In Belgium there’s no housing crisis, but that’s because the fiscal system does not encourage taking out debts. People are also more culturally in tune to this. That is not the case in some of the southern European countries and not the case at all in the U.S. The fiscal systems in these areas made it easy to take out debts through deregulation and cultural promotion of this practice. This created the housing bubbles in both regions. The governments and the people all overspent. There are all bubbles

where people have used low interest rates to take out money and now we are seeing the effects of the bursts of these.

JP: What would be a difference between the crises? You mention the difference between the governments in the U.S. vs. Europe. How does this apply to the crisis? BM: Suddenly the whole pyramid starts to collapse in both areas. That is a significant fact. Both areas had these bubbles that just broke and collapsed down. However, as you mention, there are differences. In Europe it is the governments that have spent too much money. In the U.S., there is a huge amount of money that has been taken out by the people and the government. In the states, the Fed has always printed more money to take out the deficit. In the Europe, it was not so much the people but more the governments that was overspending.

JP: Does expectations influence the overspending problem we see in Europe? BM: Yes. The real problem is in overspending and the over-expectations of economic growth. Fundamentally, economic growth is still a technical progress. There was a big technical growth in Europe in the 60s and 70s but that’s not normal for the economy. People mention that China is growing fast and it is. This is because of the “catching up phenomena.” However, eventually we will see that China’s growth will stagnate just as it did in Europe. In Europe, we experienced decreasing returns of scale, or diminishing returns. We cannot expect to get huge economic growth forever and that’s the same in the US and Europe.

JP: I know that the European Central Bank’s main mandate is to fight inflation. Why is this the case? BM: In Europe, they have been more careful with inflation because of Germany’s experience in the 1920s. German central bankers are constantly worried of a situation such as that one to return to Germany. However, they have isolated the German example and used that in all policies, which I think is a bit exaggerated. Belgium had a period where we had the opposite problem and had a recession and we see the disadvantages of fighting inflation too hard. Each country has their own problem but since Germany is powerful they want to fight the problem they observed so we fight inflation as a whole at the Eurozone.

JP: Does the fact that there are various cultures in each of the Eurozone countries have an affect on the current situation? BM: I am not an expert on culture. The history explains a lot, but fundamentally it is simplistic to say north and south because there’s also east and west. There are definitely different regions in the Eurozone but not all of what exists today should be attributed to that. The U.S. also has different regions. However, in Europe there are language and history differences, which can be a problem. But I think that oftentimes the different economies have not been taken into account. Many of the Eurozone countries are very different from each other and that is what makes it difficult to manage at times.

JP: Do you believe that since the Eurozone countries did not all follow the convergence criteria that the criteria should have been changed or that the Eurozone should have started smaller? BM: I do not think that the criteria should have been changed. It was stringent but possible. I think that if the countries agreed on something, they should have respected the rules. I think that some countries should not have been allowed in the Eurozone at the beginning because they were not committed enough. This would have made it better now.

JP: Is kicking countries out a viable option? BM: People keep talking about how Greece might leave. It is definitely a possibility that is continually being revisited. However, if Greece leaves, people might expect other countries to leave, which could get dangerous. This is what people need to realize. It is not as easy as it seems. There are costs that are not visible.

JP: Do you believe that the large lags in policy-making at the EU are part of the problem? BM: Yes definitely. It is highly inefficient. However, countries don’t want to give up their voting rights. But from an economic point of view, one country could say no and then nothing would happen. So it is not wise in this sense. This makes for very difficult decision-making.

JP: Thank you very much for your time today. Your help in understanding this issue is highly appreciated.

9.2 Interviews: Academia-‐Political Science 9.2.1 Dr. Amandine Crespy Interview with Dr. Amandine Crespy-Political Science Universite Libre Bruxelles Bio: Dr. Crespy’s research deals with conflicts over European integration, especially in relationship with the economic and social dimension of integration. She has conducted research more particularly on following topics: Euroskepticism and resistances to Europe Democracy and legitimation of the EU, EU integration and Social Democracy, and EU integration and French-German relationships.

Location: Interview was conducted in Dr. Crespy’s office at the ULB in Brussels Date: December 14, 2012 Time: 4:00p.m. -4:45 p.m. Type of Interview: In person, question and answer JP: Can you tell me a little bit about the area of interest for your research projects? AC: Main interest is about conflicts in EU integration and EU skepticism. Main piece was for my dissertation, which was about European-wide conflict in the liberalization of the service market through the directive, which was debated, in a very contentious model in 2004-2006. More recently, I have written a piece about legitimizing discourses in public responses to the debt crisis.

JP: What are your thoughts on the speed of the integration process of the EU? AC: If interested on the historical context, I would go back to before the Maastricht Union. I would remind you that it’s important to remember that the main path for the integration of the European market is market integration because historically attempts at going ahead with a genuinely political union have failed already in the 50s. I don’t know if you have heard of the European defense treaty which was discussed in the 50s but has very much failed because a majority of citizens and political elites in France and other countries did not want to go with the integration of defense at that time because the reconciliation with Germany was too fresh. The economic process has begun in the late 50s with the Treaty of Rome, but it was only the second best option. It has been incrementally pursued. Monetary aspects have become very important in the 70s

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especially after the Bretton Wood system in 1971 when monetary instabilities have been disturbing for western European countries. Of course, it is very much the economic path, but it is important to bear in mind that the creation in the monetary union was a political move in the first place. This is why we have a discrepancy that many economists have pointed and decision makers knew that the Eurozone was not an Optimum Currency Area and would not be one in the foreseeable future and this step of having a common currency was very decisive and really a turning point in the history of EU integration.

JP: So why was this decision made in spite of these economic issues? AC: Well, the main motivations just like many bargains that are made in the EU (between France and Germany) between Francois Mitterrand and Amatole. The situation was basically, and is still since, the economic German wonder of the afterwar that because of its size and geographical position and its assets, Germany is bound to be the hegemony of Europe, the economic center, which politically has already been seen as problematic by neighbor countries. This decision was made because after the fall of the Berlin wall, it was clear that German political elites wanted reunification of Germany, which would mean again this very big territory with big economic potential at the heart of Europe. The French would be a bit afraid of this comeback of the German hegemony. Creating the monetary union involving the Germans in the first place tied in the strength of the German currency, the deutschmark was a mean to create interdependence between Germany and its neighbors and avoid a dangerous comeback of German hegemony of the continent. This was the deal. German reunification would take place only under the condition that Germany would be contained by not only economic but also political interdependence between Germany and its neighbors. It was a very political decision. The problem at the time was that there had been some talks about creating some political and fiscal institutions, mechanisms, policies to accompany the monetary union and common currency, but at that time everybody including the Germans were not ready to give up that much sovereignty to really go ahead with federal structures. So they stayed with this deal about doing the common currency now because it is important and leave it to further generations of politicians to keep building this economic architecture of economic governance. Of course, it was not economically prosperous from the outset but they thought that others would create the institutions to strengthen the currencies. From the early 1990s on and the Treaty of Maastricht entered into force in 1993, EU policies and European integration has become increasingly visible in the public sphere. Before that period, the average citizen didnâ&#x20AC;&#x2122;t need to bothered about what the EU was doing. At the same time, everything became very concrete, the market started to exist, the Schengen Agreement entered into force, the countries that committed to enter had to adopt the policies, the common currency started to circulate in the

concrete form in bills and coins. Over this entire period, EU movements have become more visible in the national field and also increasingly contentious in political parties from the left but mainly from the right and far right have started to mobilize some parts of the electorate against these things. This is also the time when several countries started to have referendum about joining the Eurozone such as in Scandinavia. Skepticism was important over there. This has brought about a backlash against EU decision-makers to build further structures to strengthen the EU because of reluctance among the electorate. A new generation of politicians took all of that for granted. Their predecessors were able to make new legislation in an easier way. The new wave of politicians didn’t care too much. They wanted to be popular in their own country and they took for granted that there is a need for more institutions. But of course, it’s not done. From a theoretical period, it is also interesting. Many scholars have contested neo-functionalism. Many people have said that this idea that there would be a spillover from one policy to another is not actually happening. I am not saying that the debt crisis proves that neo-functionalism is right but the spillover might not be mechanism. If you do integrate one policy area you create some asymmetries and issues with other policy areas and some policy response will be needed.

JP: Is the Eurozone ready for further integration? AC: That is the crucial question. It is a deadlock currently because this crisis is primarily seen as a crisis of EU policymaking and as a crisis of the inability of the EU institutions to bring solutions, it further backlashes on the perceptions that citizens have of the EU. Although, I am among the people that think that increased federalism is the only way out, politically it is quite difficult at this moment. A huge responsibility is at the hands of national decision-makers and unfortunately they have proven that they are not really able to construct new discourses to convince the populations to create further institutions. There will never be a consensus but they need to get the majority. Among political elites and citizens, there has never been an agreement on what kind of institutions do they want to go toward federalism. If yes, what kind of federalism. Like American? Like German? In recent years, Belgium has been mentioned as an example of failed federalism. Something that they should not recreate or reproduce. Or do then want more co-federal institutions? Basically, that is where political liberalism lies. Should there be a transfer of loyalty to the institutions or only national governments. There is no agreement so things are happening as they are unfolding. Institutions are being created and developed in an ad hoc manner. Some things done through the EMS are very dubious from a constitutional point of view. There is no plan for the future and what’s more concerning is that no one wants to discuss the plan.

JP: Will it have to get worse to get better? AC: It is basically the story of the crisis. As long as the financial crisis and the debt crisis only impacts unemployed people and lower classes of society, it is not very likely to have a substantial impact on politics unless you come to the point where you have major social unrest, which is not excluded in some countries. In my view, because the parallel has been made with the crisis in the 1930s (in the 30s you had dozens of banks and entrepreneurs who were bankrupt and committing suicide), which is not the case in the EU. Government responses have targeted the rescue of banks, which is completely understandable from any kind of point of view because even if you are not a big friend of banks and think it is a shame to use taxpayers money to refund banks who have screwed their own activity, you know that if the bank system goes bankrupt, the entire economy will fail and the social situation will be worse for everyone. Unfortunately, I am skeptical that any major change will take place as long as the people that are running the economy are not being effective because the incentives to make it better for everyone are not visible. It is very hard to disentangle the market aspects and the institutional aspects. What you see is that every step toward more integration is being forced by the markets and decision makers only do it because they fear some negative moves on the markets. So yeah, I think there are some serious risks that as long as we don’t have a new economic shock coming from the markets or financial system or globally or major social unrest in some countries, and not only peripheral countries like Greece or Spain butt more central countries, that no major move will be made on the institutional side. That’s what I am concerned about but I hope that won’t be necessary. The optimistic point of view would say that awareness is growing that some moves have to be made and many people especially in Brussels are starting to see European elections in 2014 as a possible moment of a wide debate about the future of Europe. The debate was actually supposed to take place when the constitution or treaty was discussed from 2002-2004, but maybe public opinions were not very ripe at the moment. This debate ended in a fiasco so there is a hope that maybe having a new convention like the real Philadelphia moment of Europe after 2014.

JP: Should the system of regulation be reformed in the EU? AC: I think this has been a major concern in recent decisions, to force the member states to follow the rules. There are talks about financial sanctions for states that don’t follow the rules. This is a quite idealistic point of view. That we have common rules and because everyone commits, rules have to be respected. This is a moral point of view and this is exactly the German point of view, by Angela Merkel. They state that the Greek are guilty because they didn’t follow

the rules. But the realpolitik view is that there are big number states and small number states and the economic relative strength of a country is quite decisive determines its capacity to politically be able to respect or contest European rules or to be more or less constrained to respect them or not. The worrying aspect of the way this crisis is being dealt with is that what we see is basically very tough rules being imposed among economically destroyed countries, which really poses important questions from an economic democratic point of view. It is good to have common rules and once they are adopted member states should respect them but from a political point of view, rules will always be contested, especially these rules. Because they are adopted at a very contentious moment of crisis where a number of countries do not have a choice and where these rules have not been democratically legitimated. One very visible rule is the entrenchment of the national constitution of the prohibition of national budget deficit. This can be seen to be very problematic to enter in the constitution to change an issue, which reflects an economic paradigm because you might want to change that one day and if it’s in a constitution, it will be very difficult to change. I attended a very interesting presentation about this. It was a comparison between the US and EU and the role of the federal state. In the constitutions of the American states, you have no provision like this because you don’t want the federal state to be able to be so intrusive in this respect. Nevertheless, they do try to respect the zero deficit rule but on a voluntary basis. The paradox in this situation is that we keep saying that we don’t want a European federal state but we do adopt new rules that are much more constraining that the existing rules in the US.

JP: Do you think that the EU included too many countries too quickly? AC: I don’t know. Many people say that the enlargement between central and Eastern Europe was too quickly, but there was just political momentum for that. Clearly the end of the Cold War was there and decisions needed to be made. Again, you see that political aspects are always more important than strictly speaking economic or policy aspects. It is very difficult to think about this. There have been a lot of comparisons between the EU and various empires (seeing the EU as an empire). The peculiarity of the EU is that it is completely peaceful expansion so it is quite unique so you can’t expect that it goes without any sort of difficulty. The case for Turkey is very unique in kind of defining a European identity, but not really since there isn’t really a European identity, but to what extent we are able to integrate with countries who are very big markets and are even less developed in terms of labor law and working standards and so on.

JP: Is adding Turkey an option for most citizens? AC: If you consult citizens, most are not in favor of Turkish accession. Maybe

not for the right reasons but they aren’t in favor.

JP: Should there be a shift of the voting process in the EU? AC: Should be a shift. You can’t decide on so many policy aspects with unanimity. This is impossible.

JP: Thank you very much for your time today. I appreciate it. AC: You’re welcome.

9.2.2 Dr. Michel Huysseune Interview with Dr. Michel Huysseune, Professor and Senior Researcher of the ULB Bio: “Michel Huysseune, Ph.D., maître de conférence, is also professor of Political Science at Vesalius College (Brussels) and senior researcher at the Centre for Political Science at the Vrije Universiteit Brussel (Belgium). His fields of interest include the history of political thought, the construction of political ideologies and of nationalism in particular, and the interrelation between regionalism, nationalism and the construction of the European Union. He is the author of Modernity and Secession. The Social Sciences and the Political Discourse of the Lega Nord in Italy, Oxford, Berghahn, 2006, and of numerous articles on nationalism and regionalism in Europe.”-ULB Political Sciences Department Subjects taught: Political Theory from Machiavelli to Marx Nationalism, Ethnicity and Regional Conflict International Politics of Development Introduction to the European Union The United Nations Organization and Global Governance European identity, Euroskepticism and the Legitimacy Problem of the EU Contemporary Political Debates Location: Interview occurred over the phone Time: Interview was at 2a.m.-3a.m. Dallas time Date: September 5, 2012 Type of interview: Over the phone question and answer JP: Thank you very much Dr. Huysseune for allowing me to ask you a couple of questions. I would like to first start by asking you what you think of the decisionmaking process in the EU? MH: I think that decision-making would be more efficient through majority rule rather than through the unanimous voting process that we currently use. However, I am not sure if countries would be willing to go that far because some of the smaller countries would know that their voice would not be as significant as now. I do not think that some of the weaker countries should be as important as the strong countries like Germany because the strong are supporting the weak right now.

JP: Do you think that the fact that there are various cultures within the EU could

create a difficulty of integration? MH: Culture is often used by the politicians and media to support their country or attack another. I believe that might be true but the effects are overestimated. I think that the differences between the countries tend to be exaggerated. The media often talks about how Germany is very efficient and the southern countries are lazier but this is not always true. And I think that overemphasizing these differences can have a negative impact because it creates a sense of “antiEuropeanism”. Some countries suffer from these stereotypes because they are said to not be up to European standards and rather than help them integrate, it creates a distance from them.

JP: Since you are a historian and research subjects in international relations, what do you think that the European Union wants to become? MH: I think it wants to be something between the UN and the US. On a European level, I see the UN to be too weak of a goal and the US too much of a goal. Countries want the EU to be impactful like the US but not so integrated. We still all want to maintain some control over our affairs. The EU would never really evolve into something like the U.S. though because that is too integrative. Countries aren’t ready for that and I am not sure that they ever will be.

JP: Looking at the evolution of the EU and the current state, where do you think it will go? MH: At this point it is difficult to see where the future will go. The EU is facing serious problems on the economic level but also on integrating. There is one strong dynamic for economic unity but there are also the political reasonings for the EU. However, the cultural differences are there and some countries do not want to be united with the others so that is tough. The whole situation will either further reunite or might risk exploding.

JP: Would you think that to prevent this “explosion”, countries could get kicked out? MH: Theoretically they cannot get kicked out. But it may indeed happen.

JP: What do you mean when you say that theoretically the countries cannot get kicked out?

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MH: There is no procedure for kicking them out. I am not sure how the Commission would handle this.

JP: Is the fact that there is a unified monetary system without a common fiscal policy a problem? MH: The big problem at hand is that there is a unified monetary system without unified policies. Unified monetary systems can work great but the lack of unified policies is big. This has created problems since the beginning. This system of not having unified policies worked while the economy was wealthy but once it went downhill, the system showed its weaknesses. The problem has been raised by many people because a unified currency without a unified economic system is a problem.

JP: Seeing as to how the European Commission was not able to enforce the convergence criteria, do you think that there is a problem in that the European Commission cannot enforce rules? MH: Some of the rules are difficult to enforce and some were not enforceable. Strict rules that they wanted to apply are hard to follow through with. The dynamic of austerity becomes difficult to enforce. But there is also the problem that the EU is not centralized enough to the point where the Commission can completely enforce all of its rules. The US and other foreign bodies often critique the Eurozone for this lack of enforcing rules and for this they are quite right.

JP: It seems as though the EU Central Bank only fights inflation? Do you think this is a proper goal? MH: The European Central Bank is quite partial to history. Germany is the strongest power in the Eurozone so it is clear that they would look at their history when making decisions. If one sees German history, one can see that Germany had many inflation problems in the 1920s and they do not want this to repeat. So the ECB is highly influenced by the German Bundesbank in the 1920s. It is quite understandable but they seem to forget that another part of history could be that Belgian had a problem in the 1930s from austerity projects. It could be that if they looked at the Belgian case they would have other goals. In fact, the ECB was oblivious to this part of history and blames everything on its inflation crisis but forgets the austerity problem. This is a partial reading of history.

JP: What is necessary to move forward out of this crisis?

MH: Common fiscal authority. The way the Eurozone works now is perpetuating its problems. This reminds me a lot of a bad doctor. A bad doctor will keep giving a medicine to his patient. If this doesn’t work, instead of changing, they keep giving the bad medicine. This prolongs the problem and doesn’t change anything. One has the impression that the ECB keeps giving the bad medicine and they keep doing the same thing. They know that common fiscal authority is needed but countries don’t want to go that far. And these austerity measures don’t seem to be that great. Paul Krugman has a good diagnosis of the Euro crisis that I agree with.

JP: What might be the good medicines? MH: For sure breaking with this austerity philosophy. Being more expansive on financial policies would also be good. Secondly, making sure that state debt is not dependent on the private market and that it has some backing by public finance as it is in the United States. The US can print money and something like that should be organized in Europe.

JP: Could Europe printing money backfire? MH: Any policy can backfire but I think that since the current one isn’t working, something more drastic needs to be done.

JP: Thank you very much for your help in understanding the European crisis through a different lens. I appreciate your comments. Thanks again.

9.3 Interviews: European Union Officials 9.3.1 PB Off the Record Interview with PB164, Head of Unit for Property Projects at the European Commission Location: Interview occurred at his home in Brussels Time: Interview was from 7:27 p.m.-8:00 p.m. Date: December 16, 2012 Type of interview: In person question and answer JP: Where are you originally from? PB: Slovakia.

JP: How long have you been in Brussels? PB: 4 years

JP: So what is your current role at the European Commission? PB: I am the Head of Unit for Property Projects for Real Estate and Property Projects. I am by profession an architect. This is a special office. It is not a directorate general who is making projects. I am providing services to people who are making European policies. My unit provides projects for new office spaces for Commission officers. In my units there are architects and engineers from various countries. JP: Do you think that the EU has expanded at too quickly a pace or at the correct pace? PB: At a correct pace.

JP: What has been your role in some of the EU projects? PB: Before I was living in Bratislava, I was vice-mayor of the capital city, Bratislava. I was also city chief architect (official city planner). It was some twenty years ago. Because I was involved in the revolution from communist 164 Interviewee preferred name to be hidden.

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regime in 89 and 90. And then, in 90 I was one of the founders of so called Europe and Democratic Forum in Strasbourg. And this Europe and democratic forum was conceived of some dreams of a big Europe state. I was just one, which was a technical engineer. All others were sociologists or writers or philosophers, etc. It was a group of some 25 people from various countries that have been four important countries have been in the European Union. There were people from France, Germany, Spain, and Italy but also us from Czekoslovakia, Hungary, and Poland. These eight countries represented a group of visionaries from all of Europe. Our aim in 91 was that all central European countries would enter one day in Europe together. This day came. At that time, some 20 years ago, everybody thought we were crazy. This would not be possible. It would not be as we wished. But finally our dream was fulfilled. Some 13-14 years later.

JP: Does Slovakia use the euro? PB: Yes

JP: Do you think that if the EU moves more towards majority voting that the voice of a small country such as Slovakia will not be heard? PB: Not sure. Without knowing much about this, I have a feeling or hope that they make good decisions in a harmonious way. I do not expect small countries to be hurt.

JP: Do you think it is possible to create a European identity? PB: We came as a wave of 10 countries. I believe that programs such as Erasmus helps to create the European identity. My daughter, Barbara, could make studies in different European countries, could meet people of her age from different countries, and this generation (your generation) in Europe have a possibility to make a mixture of friendships and perhaps families later which will be not just national families. That is how Europeans are born, change within Europe. This mobility issue and the possibility to work outside of their home country are very helpful in creating this identity.

JP: Do you see that some of this education abroad turns into employment abroad? PB: Yes that would be great. Some 25 years ago there was that clear barrier

between Western Europe and Eastern Europe between communist and capitalist Europe. Now we don’t have that barrier and it is clear that we share ideas and knowledge. I am happy about that.

JP: How is the EU viewed by citizens in Slovakia? PB: Not very well viewed by citizens. I didn’t see a barometer or anything. I suppose that it is the lowest in the history in 50 years. My feeling is that it is the worst right now so in Slovakia, in comparison with other countries, I think that in Slovakia, the European Union is quite well viewed, but not so well as some 10 years ago. Slovakia was created on the 1st of 1993 and then in 1998, there was a referendum to see if we wanted to enter into the union. It was successful. It was just one referendum, which was organized in our country after 1989. There was only 50% of participation in the referendum. The referendums were not successful because not enough people voted. For the succession, it was the only one where enough people came and somewhere between 78-80 percent of people were for the EU. So it was good. For today’s pool, if the referendum was today, it would be no. People would not go to the vote and it will not be successful. At that time, I organized tours in Slovakia to speak with people about why it is important, why I am positive for succession.

JP: What would you tell the people? PB: I focused my talks on four benefits of the EU for the people: Freedom of movement, freedom for the children to make studies, international help to each other because there is also some practical issues, and also ethics.

JP: Do you think succession has been good, economically? PB: For Slovakia yes. If you look at indicators, Slovak economy is one of the best. The trend is very positive in comparison with big economies. It is sure that it is on another level but the trend is better in Slovakia than in other countries.

JP: So in the end, you are optimistic for Europe and think it will get out of the crisis successful? PB: Yes. I think it has been great for my country and I believe in fighting for Europe.

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JP: Thank you very much for your time and inviting me to your home. 9.3.2 HG Off the Record Interview with HG165, Development Officer of the European Commission Location: Interview occurred at her office at the European Commission Time: Interview was from 3:00p.m.-4:15p.m. Date: August 10, 2012 Type of interview: In person question and answer JP: Thank you for meeting with me today to ask you a couple of questions. I would first like to start by asking if you think that there needs to be one common fiscal authority in the EU? HG: I do not think it is possible at the moment. Things have to get much worse before countries could agree on something like that because they have to give up a lot of sovereignty. Germany would be in favor because they know they can influence but others who have a weaker position know they have to accept the opinion of the strong. Whatever is good for the strong will be done. The weaker ones wouldn’t be the ones controlling the EU. It will have to happen if they want to get a sound system in the end. What will happen is that it will be an intermediate system moving slowly towards it but not having it now.

JP: Do you think that if the convergence criteria had been met the current situation would have been avoided? HG: It was open that all countries were cheating and some more than others. In the Commission, they knew that Greece and Italy were cheating massively. When they were divulging the information to their superiors, they were being called saying that the Commission can’t question what is being sent by member states. They have to accept it. The government’s submission is what they submit and that is what they have to base it on.

JP: Should there be a stricter entrance to the Euro? HG: Yes. However, there is no use to look past and observe what had happened. The EU has always been a sort of process where you go as far as you can at the time. That’s what was possible at the time. If there were stricter 165 Interviewee preferred name to be hidden.

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criteria or more stringent controls, things would have been different. There would have been a smaller Eurozone, more solid, and things would have taken longer. I am not sure that would have impacted the world. A very small Eurozone would have created problems of acceptability. At the time you would never have been able to get a different solution, to exclude countries. The parameters that were set were the only thing that was acceptable. You couldn’t have gotten stricter parameters or a control mechanism to see what the member states were sending. You have to work with what you get at the moment.

JP: Is kicking countries out an option at this moment? HG: It wouldn’t be good because for them to go back to old currencies. That is honestly difficult to conceive. That can only be exercised if keeping the country in would destroy the Eurozone. We are trying to keep everyone on board as long as possible. Solidarity needs to be shown to the others as long as they make the efforts themselves. That’s what Europe is all about.

JP: Should there be unanimous voting in the EU? HG: We have reformed the voting rights. They went as far as they can go. That’s the line. They cannot go any further in pushing sovereignty of individual member states. Always moving towards more rights at the European level. At the moment, there’s no room for pushing voting rights further. The populations of the countries and the national parliaments would protest. They have become largely a rubber-stamping of whatever is done in Brussels already. A further move in term of voting rights would be met with resistance, even though it would be desirable.

JP: Will people be able to see themselves as European one day? HG: I have just joined a movement about believing in Europe. Many people coming from member states have a much more national perspective which is different from the people who came with the Council and are diplomats. There is a lot of idealism in the European communities. On the other hand is a stronger movement of Brussels-bashing which is convenient for the national governments because they are not being blamed so whatever goes wrong is Brussels. Some of the member states are very anti-European. The uneducated, the ones that don’t know any better or are not getting their own sources of information and just listening to mass media. That is a real issue that will make it difficult to form a very European system. I am very hopeful that people will think of themselves as European no matter what because there is a massive youth exchange program,

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Erasmus, so millions of young people have spent time in another country. That is forming the European system. They are in an age where they fall in love and come back with a boyfriend or girlfriend so that is a form to interlink the countries. That is a reality in many ways. Since it’s the young who are carrying that, it will become a permanent thing. Also, the economic dependency is one common market. That is a reality that will have a very strong pull towards the joint identity. It will never be like the U.S. These are 27 countries, which for hundreds and thousands of years have developed their own identity, language, and cultural distinctions. I would hate to have Germanized Europe or Frennchised Europe. I want to feel like when I am in Italy I am in Italy and in France when I am in France. Each country has to bring the strengths to Europe. We have to build on the strengths of each country rather than looking at the weak parts of each nation. Europe, even if it goes much faster and further, they will never end up having a completely federalized system. That is going too far for them.

JP: Do you see the austerity program working? HG: I am a critic of the German approach, which is too austere, and no investment. Investments are necessary in this period and they will pay off in the long-run. Yes you have to be economical but saving at the wrong spot will hurt you in the long run. You have to continue to invest in education. If you stop that, you’re gone because that’s the future. You have to invest in infrastructure and innovation. Those are the basic elements to assure you’re future even in a crisis. Too much on austerity and not enough on necessary investments. That’s why I’m happy France is trying to balance that with the new government.

JP: It seems as though the European Central Bank is highly influenced by German history. What are your thoughts on that? HG: That is a political decision and Germany has a strong voice in this because they are the strongest economy. There are dissenting voices in the choir. With France’s current government that can change.

JP: Could culture block political incentives? HG: No. There is still political will. If we get a political will, we will get a way to do that.

JP: You mention political will. Do you think that the Euro’s continuation is completely political?

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HG: It is inconceivable for the countries in the EU to go back to their previous currencies. So much inter-trade and a common market. It has become a transaction economy so to go back to individual currencies is inconceivable. And would have dramatic impact. I definitely see economic benefits to it as well.

JP: Is it positive to keep the Euro for all countries? HG: It is in the long-term interest of all the other players to keep the Euro. Some countries wish their currencies dominated, like the US. However, it is good for the world to have its supplies in different currencies. It is not good to have all eggs in one basket like in one currency. You have to spread your risk. If there is more larger currencies around, it’s in the interest of everybody.

JP: How do you think citizens of the EU view the Euro? HG: I think that there is a distrust of the image of the EU and the stability is tarnished. I think that we will get out of this and that the Euro will come up on top.

JP: Should all countries in the European Union use the euro? HG: Countries who don’t want it shouldn’t be forced. It should be voluntary. There is enough economic attraction to convince people to join. Those who want to stay out should stay out. They shouldn’t be forced and it couldn’t be forced. Joining the Eurozone means giving up so much control over your economy. It will not work if the country is not in favor and the EU has no means to force it. It’s the sovereign decision.

JP: Should all countries in the European Union have the same voice in subjects relating to the Eurozone? HG: There should be the same voice on other subjects but not Eurozone subjects. Everybody’s affected by decisions taken on the Eurozone. The ones in the EU should have a say but not the same say as the joint currency. There is a two-tier program.

JP: Seeing as you work specifically in EU development projects, what do you see as the impact of the crisis on development?

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HG; Due to the crisis, member states are less likely to give development aid. Budgets are tighter and in countries like Spain, the development was cut in half. To become more effective and efficient in giving development aid has become a real issue. Also, we have to justify more what we’re doing in terms of development aid. They want to see returns on what is doing in terms of wellbeing of populations but also in business opportunities or reduced risk like crime and international terrorism. They are much more challenged to show the returns of development aid.

JP: Also, another area of your expertise is external relations. What is the impact on external relations? HG: The EU has served and is still serving as a model for many countries. Recently, due to the crisis, that model has become tarnished. We have already heard several times that external actors don’t trust us as much anymore. I was in Africa when I heard people start to preach, “You need to go back home and clean up your own front door”. Our ability to sell the European model has been tarnished in selling the European model to other countries. And that is on the political front. The economic difficulties are having repercussions on political relations.

JP: Thank you for your time today. It has been a pleasure. HG: I enjoyed speaking with you. However, I would like to mention that all of my comments today do not reflect the opinion of my job at the Commission or of the EU as a whole. I have spoken completely honestly in my personal opinions. I could face serious repercussions if it seemed as though these comments were those of the Commission or of my job, so I would appreciate discretion in mentioning them. If you were to directly quote me, I would prefer to be quoted in the following manner: “In the personal interview of a staff member of the EU...working in the field of External Relations” JP: That is not an issue. I will ensure that everything is quoted correctly and properly. I appreciate you speaking so honestly.

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9.3.3 Dr. PW Off the Record Interview with PW166 Bio: Head of Greek Task Force Location: I met with him at his office at the European Commission and then we walked to have a coffee at a coffee shop in the European Commission Time: Interview was from 9:00a.m.-9:30a.m. Date: December 22, 2013 Type of interview: We had a brief discussion

JP: Thank you for meeting with me. PW: You are welcome. I hope you enjoyed your meeting with the rest of my team. He is more versed on the economic issues than me.

JP: I did and would still like to hear some of your thoughts. PW: Sure.

JP: Do you think the Maastricht Treaty rules should be amended or improved seeing that few countries respected them? PW: I think something needs to be done. However, at the time the Maastricht treaty was the best we could do. I don’t think we could have forced countries to abandon more of their sovereignty than they were already giving up so I am not criticizing the treaty. However, if it happened then, we are saying that it can happen again because we didn’t and haven’t done anything really to reprimand countries. I think that what happened could happen today. France and Germany, the two main countries throughout the history of the European project, ignored the rules or had them changed as it was best for them so I would not be shocked that if we amended the Maastricht Treaty or came up with a new plan for the future economic state of the EU it would not happen again.

JP: Is there any way to address this issue and make states more accountable? PW: With the experience of what happened to the Maastricht Criteria, this is still 166 Interviewee preferred name to be hidden.

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likely to happen in the future. I am not sure we are at a point in the construction of Europe to where we could get all the nations to sign something which would further bind them to the Commission.

JP: Do you think unanimity should be removed from economic issues to promote speed of action? PW: This is an inherent issue in the whole architecture of the EU. The whole model is built on unanimity. No one is isolated or excluded. Even in areas where the Treaty does not require unanimity of a proposal, one usually is very close to it. Very rarely a nation is ignored.

JP: However, surely the issues of every nation are not regarded in the same light? PW: However, in any such systems, one can see certain patterns in the sense that of course the worries of smaller states are taken less seriously than those of large and middle states. If it were only Greece and Portugal who had problems, the other 25 would probably have a closer look. Wouldn’t be too strict or allow deviation but would look. As happened with the Maastricht Criteria, two big ones are against something, things might be taken more lightly and that is of course where one could say it wasn’t so bad and corrected after but with any set of rules, once you start violating and once the biggest ones started violating them, then the whole supervision on everyone else becomes lighter. This is very human.

JP: Should the rules set by the EU be stricter and force nations to be more accountable? PW: We start with soft coordination and then move towards stricter rules. It was definitely enough as much as one could achieve. One should not forget either that the model of the ECB is built on the Deutsche Bundesbank. That was far from being normal in independence. Everything that we do is somewhat of a compromise. In terms of crisis, at a certain moment we notice that it was just a benchmark and voluntary agreements but at a certain moment we realize that it was not enough. There were too many that had strong interests to deviate and then that’s how we find ourselves in this situation. In the end of the 90s we noticed that we needed more cohesion, more structures, change pensions, etc. Discussions didn’t help and benchmark approach didn’t work so we moved progressively to something that is stricter.

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JP: Are countries ready to give up more sovereignty and for the EU to create more federal institutions? PW: In many ways they have already given up almost all their sovereignty. The whole project was about giving up sovereignty. Notably, times as difficult and emotional as we are gracing now, we don’t expect everyone to act rationally and give up everything. It is still a compromise. We are trying to see what the future set of rules will be, how binding they will be, and country recommendations how strong they should be. We discussed a year ago that everything would have to be a fixed set of rules but now that it’s more concrete, even those in favor have second thoughts. Germany, Netherlands, etc. want strong rules but for Greece. Not for themselves. So then they start to notice that they don’t want such strong rules. This is a fluid model and opinions change quickly.

PW: I have a meeting and have to go. JP: That is fine. Thank you for your time.

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9.3.4 Dr. GS Off the Record Interview with GS167 , Chief Economist of the Greek Task Force Team at the European Commission Location: Interview occurred at his office at the European Commission Time: Interview was from 8:00a.m. to 8:43 a.m. Date: December 22, 2012 Type of interview: In person question and answer JP: Dr. GS, can you tell me about some of your research projects and how you came to the Greek Task Force? GS: My real job is in academia. I am a professor of economics in Madrid in Carlos III. I did my PhD in Brussels and my thesis was on Andre Sapir. He is an incredibly influential guy in European integration. He has written countless articles on the EMU. He is ranked as one of the 10 most influential people in Brussels. He also works at the Bruegel think tank. You should look into his work. I did my PhD in ULB with Sapir. Then I went to the Bank of Spain and then went straight to academia. I have been teaching industrial economics and intro to IPE. So kind of integration stuff. In 2008, I was called to join the chief economics team of competition. This is antitrust in the commission, which in Europe is important. This is where the commission has most power. This has an effect beyond national borders. I was there for 3 years and we decided to go back to Spain and when everything was settled with the kids back to school in Madrid, the task force for Greece was created and our job is to provide technical assistance to implement the many reforms that they have to meet. Basically Greece is under an IMF-like plan but it’s financed 1/3 by the IMF and 2/3rds by the EU and member states. When the task force was created, I felt I had an obligation to try to help so my family went to Madrid and I stayed here. I deal with horizontal issues and specific dociers. Some social security, innovation, labor market, some schemes for tax collection, vat, etc.

JP: Can you tell me about some of the programs that are being put in place for Greece? GS: We are currently heading for the third program. The first two have not worked. Now once things do not work very well, the blame game starts and there is no doubt that the Greek authorities are responsible for not doing the homework. It is a question of whether they didn’t want to or couldn’t but Greece is not a modern European state. Public administration is a complete disaster. There are many things that Greece cannot deliver. This all takes time. 167 Interviewee preferred name to be hidden.

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Overhauling a state bureaucracy that has been inefficient for centuries, takes time. They couldn’t or wouldn’t so that’s part of the blame. But the design of the first two plans was not perfect and even if the Greeks had done all their homework, the numbers did not add up. I don’t want to go into detail on the fiscal multiplier and the external factors. The IMF has been more outspoken in stating why it didn’t work. Now we are having the third adjustment plan that will be extended over time as compared to the initial time horizon, which was contemplated and will probably involve larger loans than before. It is likely that you will have to have some sort of further debt relief even though it is not officially accepted.

JP: Can you tell me about the role the ECB is taking to help support Greece? GS: The ECB is a monetary mandate over the whole of the Eurozone. In that mandate, you have price stability of course but you have other aspects, which were not thought a lot about. Among which is the so-called monetary transmission mechanism that interest rates set by the central bank should feed through commercial rates. The central bank has decided that this mechanism does not work so they may have to intervene to make it work. This is highly controversial. If the central bank does this so called open market operations, there would be lots of conditions around this. It is a very powerful weapon. The European Central bank can do things. It has certainly not been cooperative but it is only one player. It is a question of debate about whether it has been doing enough in respect to Greece. My understanding, which is personal, that the ECB has not been the most problematic actor. Right now, debt buyback has been completely successful just last week. Greece was leant money to buy back its debt on the secondary market. The ECB has decided to accept Greek government bonds as collateral to lend to commercial banks, which hold the debts.

JP: So what have been some of the more problematic actors? GS: I would prefer not to point fingers. The European way to do this of muddling through things and buying time is not adequate for a crisis such as this. This has worked in the past. We sit, we think, we negotiate, we agree to come back to revisit the problem. That has worked well on many dociers but not for a crisis like this. The cost of inaction or muddling through or delaying hard decisions is extremely costly. This has been true not only for Greece but for the whole management of the EU. We took far too much time to realize to do something about commercial banks in Europe. It took us a long time to visit this issue of private banks or real estate developers or both depending on the crisis. Spain is in trouble. But the Spanish sovereign had very sound banking. It was all in the

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private sector. In Greece it was the other situation. We are talking about billions of dollars. This gives us an idea of how quickly the costs of the crisis can grow because we fail to act concisely and quickly. Today, I see the problem of the EU to be way beyond Greece. You can take Greece and send it to another galaxy and we still have a problem here. Politics, too often in this crisis has not been part of the solution but has been part of the problem. It is very easy to blame markets. Sometimes they are rational. But the way they react in Europe, you have in large part they act in mistrust of our politicians on various levels, the supranational or the country capital to have taken true or haven’t taken the full dimension of this crisis to fix this. The more you push back the hard choices into the future, the higher the cost.

JP: Will Europe need more federalism to fix this? GS: Yes, no doubt. But you cannot do it the old way where you do a little here and then you do a bit more tomorrow and at the end of a day I will build a house irrationally but you will have a house because you have built pieces. This time, you have to have a plan with an architect and start from the foundation. You have to know where everything will be. You cannot improvise. You need to have good synchronization between the different building partners. And a good credit line from the bank to pay the builders and supplies with sufficient collateral to pay back your loans. There is no doubt that more integration is needed but doing it slowly has worked in the past, but in this case it won’t be enough.

JP: Are the citizens ready for such a situation? GS: No. Because the current generation of political leaders contrary to the previous generation are early to remember politicians of the late 80s and early 90s and have not taken enough responsibility to convince their electorates to do advocacy for the projects. There has been a bad tendency to take credit for whatever good comes and blame the EU for whatever bad happens. I advise you to read the blog of Jean Quatremar (http://bruxelles.blogs.liberation.fr/) who is a blogger and writes in the newspaper. He has one of the best blogs on European affairs. You will find lots of good information there. He is 90% accurate on what he says in terms of facts. He compares the current budget of negotiation and the dynamic between all actors vs. what was happening 15 years ago when you had to convince the net contributors to the EU budget to double the amount of money that was going to go for so-called cohesion that happened twice. So if you want to actually see how citizens are or are not prepared for this leap, I think you have lots of information there. I don’t want to talk about certain politicians. It is very difficult today to explain to some northern countries not to let Greece sink. But my gut feeling is that 20 years ago, you would have had

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politicians of left and right and center willing to go to their public and tell the people that it doesn’t look in their interest but we need to keep them.

JP: Should there be another mechanism for the regulation of countries? GS: We issue directives here and then allow the country to implement it themselves. What often happens is that a government adds stuff within the directive. The directive only sets the framework. Once the directive is implemented, we don’t go and check how they implement it. We have been asking for correlation tables to see the requirements from the EU directive and then create transparency so that citizens know what is coming from the EU and what comes from the member states. Though in some ways, some countries don’t follow the entire law and some add more laws. So the answer is yes. We look at what the country is doing and if there is a complaint, our lawyers here will call the country in. Then we will call them in and tell them. The member states can reply and sometimes there are issues of understanding or they note that they have overlooked something. This moves to more formal exchanges of letters where we give them a certain time to reply and explain what they are doing to address the situation. This whole thing takes its time. If then at a certain moment we see that the problem definitely exists, and the country admits it’s an issue but doesn’t address it, we go to the court. We don’t do that often, but we can. It then rules on the compatibility of the mechanisms on EU law and then the rulings are done. If the Commission was right and the court agrees, then the country gets a certain delay to implement the changes and as of that date they pay fines. This can be millions of Euros. There are certain areas where I guess member states prefer playing it long because the process takes a while and the economic interest of keeping the position, they prefer to pay the fine. Some are quite expensive. Usually when the court date is set, the country starts to implement changes.

JP: Thank you for your time today.

9.4 Interviews: Third Party 9.4.1 Jean Gabriel Arqueros Interview with Jean-Gabriel Arqueros: Vice President of Societe Generale Bio: Jean-Gabriel Arqueros is a Global Market Manager and Vice-President at Societe Generale Private Banking. He is also the Director of Russian and Eastern European Relations.

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Location: Interview occurred in Mr. Arqueros’ house in Geneva, Switzerland Time: Interview was from 10a.m.-1p.m. Date: July 14, 2012 Type of interview: In person question and answer over lunch JP: I hope you are doing well. Thank you for meeting with me. Mr. Arqueros, tell me a little about your history with banking? JA: I currently live in Geneva and have worked with Societe Generale for quite some time starting in Paris and now here in Switzerland. I work in private banking with high net worth individuals mostly from Russia and Eastern Europe.

JP: Why do people send their money to Swiss banks? JA: Swiss banks have for a long time proven themselves to be profitable for international organizations. There are many tax benefits for individuals in investing their money in Switzerland and our banks are here to provide individuals with various strategies to maximize their portfolios.

JP: What is the current situation in the relations between Switzerland and the EU and US? JA: Currently the situation is quite tense. Many European nations and the U.S. Believe that the reason why they are in recession is because the rich in their countries place their money in Switzerland and receive greater benefits than if they would keep their money in national banks.

JP: Do you think that “hiding their money in Switzerland” could be a major cause of the recession? JA: I think that is absolutely incorrect and not a large reason at all. Our banks have been in operation for many years and if individuals think that the benefits for them are greater in investing in Switzerland as opposed to in their countries, a federal government should not be able to sway this.

JP: What about tax evasion? JA: Swiss banks have been known for their discretion and this is currently changing. The United States and EU have been suing many of our bankers and those of our competitors trying to get us to divulge information but that defeats

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the whole purpose of our discretion policies.

JP: What is Switzerland doing in response? JA: Switzerland is currently engaging in a sort of financial war against the US and EU. We accept very few accounts from these two areas and are trying to limit our relations in private banking with them.

JP: Which regions in the world are currently growing for you? JA: We are receiving many clients from Eastern Europe and Russia, hence why we developed my whole office to direct those clients. We also have a good amount from Asia and then a lot from Latin America. These are all booming markets so our operations have simply shifted but not disappeared. We are not opposed to returning to our previous relationship with the US and EU but need the same respect we have shown to them.

JP: Why doesn’t Switzerland enter the EU? JA: While it does seem to hold many benefits, the EU does not currently seem to be in a situation where it can handle the amounts of countries already in it. The Euro is still stable because investors still have hope in this currency but once that hope is lost, it will go downhill.

JP: Do you expect hope to be lost soon? JA: I do. If one looks at the governance of the EU and its inability to act effectively and efficiently, it seems quite clear that something is wrong. The system might never be perfected but something still needs to be changed.

JP: What problems do you see in the EU that have lead to this? JA: The problems we see today are not new ones in any regard. These have existed since the start. It has been hard for the EU to get to where it is today but that takes time. It is completely normal. However, the EU tried to form itself too quickly and did not regulate itself internally so a chaotic system was created where the Eurozone quickly expanded in size but not in stability so we now have the large yet unstable Eurozone today. People knew that the large problem was that the common currency without one central authority was a problem and they

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mentioned it but no one ever listened. This system would have worked for a little longer as the EU still worked out what it was going to do about having a single authority but the crisis hit and corrupted the system. Europe was not ready for this and it is evident now.

JP: Switzerland is not in the EU but what is the view of the EU from Switzerland’s point of view? JA: It seems as though Europe is really trying but no one country is willing to make the sacrifices necessary to move forward. All of the nations are looking too much for each of their own benefits. Huge sacrifices are going to have to be made but nations aren’t willing to go that far. I wonder how long it will take for nations to get desperate.

JP: But yet many nations are still trying to join the Eurozone. Why is that? JA: While it seems to be in chaos, it is not a bad system. It just needs some structural improvement. Being in the Eurozone can really help a country improve on a level of finances and legitimacy so the desire is understandable. It might not be a good period now but over the long-run this could be beneficial to a nation.

JP: I see that there are few jobs in countries like Spain, is this the case in all of Europe? JA: Not at all. There are definitely jobs in Europe. Germany, France, the Netherlands, etc. have normal levels of unemployment, but there are still jobs. The problem with Europe, which makes it depart from the optimal currency area discussion, is that there really is not a mobility of labor. This is one of the reasons why the European Union was formed but the current situation has not enabled this to actually be a fact. This ignores the fact that it is difficult for someone of one country to move to another because of the language and cultural differences, which create a huge dichotomy between the individual and the new nation. Spanish people especially are very closely tied to their family and friends and are not particularly skilled on a European level with languages so it is normal that more of them stay in the country.

JP: I heard something about the Portuguese Prime Minister encouraging people to go seek jobs in former Portuguese colonies. What do you think of this? JA: I think he is doing well. Portuguese people are not finding jobs in Portugal so

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it is better to go elsewhere and find jobs. Finding jobs in former Portuguese colonies such as Brazil is perfect because it eliminates the language barrier and Brazil is really booming so there is opportunity there. However, this eliminates the fact that it is difficult to transfer to Brazil but culturally Brazil is not too different from Portugal. However, this does send out the message that the government can no longer do anything for its citizens, which received much critique.

JP: Thank you very much for your time today. I appreciate it.

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9.4.2 Dr. Zsolt Darvas Interview with Dr. Zsolt Darvas, Bruegel Think Tank Bio: Zsolt Darvas, a Hungarian citizen, joined Bruegel as a Visiting Fellow in September 2008 and continued his work at Bruegel as a Research Fellow from January 2009. He is also Research Fellow at the Institute of Economics of the Hungarian Academy of Sciences and Associate Professor at the Corvinus University of Budapest. From 2005 to 2008, he was the Research Advisor of the Argenta Financial Research Group in Budapest. Before that, he worked at the research unit of the Central Bank of Hungary (1994-2005) where he served as Deputy Head. Zsolt holds a Ph.D. in Economics from Corvinus University of Budapest where he teaches courses in Econometrics and but also in other institutions since 1994. His research interests include macroeconomics, international economics, central banking and time series analysis. Location: Interview occurred at a meeting room at Bruegel Think Tank Time: Interview was from 2:07 p.m.-3:05p.m. Date: December 14, 2012 Type of interview: In person question and answer

JP: Could you tell me a little about your research projects? ZD: I have been a research fellow for 4 years. I work on European macroeconomic issues. Finance and growth also.

JP: Where are you from? ZD: Hungary.

JP: What do you think about the decision-making process of the EU? ZD: I think that there is no strong centralized decision-making body. Instead there are many decision-making groups. Many large number of bodies and most important decisions are made by governing member states, which is clearly an inefficient and slow process. Many member states are following their own interest and this many times prohibits quick and defective decision-making. Also, there was a lack of recognition of the problems, which have been denied for long time, and then it was unavoidable to do something and their decisions came too late and became costly for all involved.

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JP: Is a fiscal union necessary for the EU? ZD: Certainly some would help. Some people mean different things by this, however. At the commission, it means more of a harmonization of budgetary institutions, which is not the fiscal union I mean. I mean that they pool resources for common goals. This is not really happening even though after many many denials the EU issued a blueprint for a general union about two weeks ago. In the long term fiscal capacity of the EU area may be justified or needed. At long last, the EU commission realized that after everything else has been done, it might not be enough after all. There is a consistency project with the EU budget. Clearly this is politically not possible or realistic.

JP: Is it tough politically to create this? ZD: The EU is a treaty-based organization. The treaty sets the role of the EU. If that has to be changed, every country has to approve that and in some countries a referendum is needed so therefore it is typically regarded that changing the treaty is a cumbersome and unpredictable process. In Ireland there was a vote against it and in France and the Netherlands there were votes against a constitution. Any country can block the process so there are some intergovernmental treaties. It is easier to make an intergovernmental treaty but it is tough to amend the treaty itself. First there needs to be an agreement and after there is an agreement, each country has to approve. The way it is constructed, it makes it difficult to achieve a higher level of integration.

JP: Is the Eurozone an Optimum Currency Area? ZD: Clearly not. Any measure of labor mobility inside the EU is much lower than in other federations. If you look at financial flows, they are flowing quite freely. One of the greatest achievements was the increase in financial integration. The growth flows increased dramatically. Interest rates became quite close to each other. Before the crisis there was a clear integration of finance which was a success and which helps for the monetary union to function better but there was a significant setback since the crisis. The ECB has many nice reports that on any measure, everything has reversed. They have not reached the level of the early 1990s but clearly financial fragmentation has started inside the EU area.

JP: Is the role of the ECB enough? ZD: ECB differs greatly from the Federal Reserve in that it is not backed by a

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single treasury. If the US, in hypothetical terms if the Fed would assume losses, there would be an agreement with the Treasury and they could solve the issue. In Europe, there are 17 treasuries and therefore this limits quite significantly the scope for policy actions of the ECB. I think that so far the ECB was the most effective European institution. During the first years of the crisis in 2007, they started massively increasing operations and even expanded. They started the securities market program in 2010, which was successful, but when it was not successful they started open market transactions, which clearly helped Italy and Spain. Mr. Dragi in 2007 said that the ECB was ready to do whatever is needed to help Europe. Their mandate is price stability but they decided to help have an effective monetary transmission mechanism but that was not successful. The ECB interest rate does not transmit well to private interest rate. They basically interpreted this that it was in their mandate to support the states that are struggling. ECB still fights inflation. They do interfere in government markets but if you look at the US Fed, it does not purchase any securities of states like it never purchases those of California or Alaska for example. The ECB purchases securities for example. But the US has a Federal government and in the EU on the contrary we have states with high debt. In this sense, the ECB actions are very much justified and again this is a good example that the ECB should do something similar but when they recognized that the ECB is the only institution which can stable in the short term, they changed their position which indicated that they are ready to recognize that changes in the policy are needed and are ready to make positive improvements. I am quite happy with the ECB and it has been the most successful among European institutions. But certainly the ECB wonâ&#x20AC;&#x2122;t solve the crisis alone. Certainly it takes time to solve the problems and gaining time is important in time of crisis.

JP: What do you consider some of the less successful institutions? ZD: All other institutions are clearly less successful but there are so many. If you look at the European Council, they always try to do the minimum with what is needed to stabilize the situation in the short term. In some case they were successful because the Euro crisis has not expanded but within the realm of their competencies, they came out with some measures which temporarily helped but not in the long term so have to continuously come up with new short-term remedies and cannot address the crisis in the long term. If you compare the economic developments in the Euro area and the US, the US is on a path of growth, unemployment is decreasing, and output level is higher than before the crisis but in the Euro area there is economic stagnation, output is below precrisis, employment does not expand so clearly the macroeconomic outcome is lower than in the US. So you can say that the Euro organizations are not successful. The Commission can make proposals and up to November of last month, they were always behind the curve. They came out with a proposal too

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late. They only said what was politically realistic considering the circumstances of the time and therefore many people rightly criticized the Commission, I think rightly. They realize this is the case so they changed their plan. Mr. Barroso, in his annual state to the speech, they called for a federation of states in Europe. That was the first signal that they were more forward looking in proposing something which would benefit Europe in the long term, not short term. Then two weeks ago they put together a proposal where they consider all major issues. If you look at the banking union, the EU commission did not propose the banking union. Nicholas Veron is a strong proponent of the banking union. In May we were looking at where the banking union or the euro would come sooner. The banking union was not at all on the table and if you look now, European leaders recognize that you either have to implement euro bonds or a banking union. The EU did not propose those so market pressures got them. The Commission chose the route of the banking union.

JP: Where is the EU at in terms of banking union? ZD: First part has been agreed on. Supervisory system has been agreed. ECB supervises banks, which assess more than 30 million euros, or those banks that have a GDP of more than 20% of the country so essentially they monitor the large banks. Also the ECB will have the right to look at smaller banks. This has now been agreed upon. Sometime next year the supervisor will start and then it will be complemented with a few more resolutions but at least it has been agreed upon and has started. It is really a major step.

JP: Do you think Euro bonds are going to be included in these efforts? ZD: I think that for the functioning of the euro it would be very beneficial to have some euro bonds, but I doubt that in the short or medium terms, euro bonds would come because there are major fears among countries to pool the responsibility of the total debt area or Germans figure that they need to pay for Italian debt. German people have a strong resistance against euro bonds so I donâ&#x20AC;&#x2122;t expect that this will come.

JP: Is it easier to implement this now or after the economic problems have passed? ZD: Earlier, euro bonds may not be needed. Euro bonds are needed at a time when governments are facing funding constraints or are facing too high costs of borrowing. In Spain and Italy borrowing costs have declined after open market transactions but are still reasonably high. But they could use this now greatly

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because this would help lending to the private sector. They would need it now. Suppose in 5 years the crisis is over and economic growth is progressing and public debt is declining, then at that point there won’t be much need. The euro bonds are needed when there is market pressure. If there won’t be euro bonds during the crisis, I don’t expect them to be introduced after the crisis because the need is lowered and the political resistance is still there.

JP: Should the ECB be Lender of Last Resort? ZD: It has started in a sense because they are purchasing a limited amount of government securities. The government must have a financial assistance program and they should fully comply with all requirements of the program and the government should continue to borrow from a country. But now they can purchase an unlimited amount of securities. So basically they said that it is conditional depending on the program but that they will assume such a role.

JP: Are austerity measures doing more harm than good? ZD: Answer is clearly yes and no. Clearly they are hurting the countries. It all depends on how large the fiscal multipliers are. In some countries there is no choice. In Greece or Spain or Ireland there is no choice because they need fiscal consolidation. They have high government deficit. The fiscal situation on a whole is better than in the US. Any outlook of this shows that the EU area is in a much better position. Here we have a strong focus on fiscal consolidation. There is more area for fiscal expansion here. So there will be indeed scope for something to do with the fiscal policy but again since there is no fiscal austerity for the EU area and each state does what they think is best for themselves and what is allowed by the EU fiscal rules, the lack of EU fiscal policies, hurts as a whole. The fiscal issue, which is important to recognize, is that we are in a situation where banks don’t want to lend much and you need to meet tougher regulation. A large part of the private sector is indebted. These two factors are creating an overall demand decrease. At the time when this changes, there will be a scope for a more expansionary policy which is done in the US and the opposite of which is done in the EU area. The hope here is that with a fiscal consolidation, trust will be restored and trust in the markets. If trust is restored, then sooner or later people will be happy but the problem is that since the Euro economies are going down especially in southern regions, trust will not be restored.

JP: Should the ECB have forced countries to observe the Maastricht Treaty more closely?

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ZD: Yes, without doubt. We have seen that the problem countries are those that had either high public debt when the crisis started like Greece or Italy or those countries that had high inflation during the implementation of the euro like Spain or Ireland because these countries had unsustainable credit and housing booms. Clearly, the ECB controls the inflation on a whole but inflation was higher in Spain or Ireland, Spanish authorities should have implemented measures to control that. So they should have limited the extent of the booms and different tax policies to dampen the housing boom this would have made these countries less vulnerable when the crisis started in the US.

JP: Was the Eurozone formed too quickly to be able to maintain stability? ZD: Without a doubt. If southern euro countries were without the euro area, there would be no crisis at all. The currencies of these countries would have depreciated during the past few years and they would have much higher inflation and even the pre crisis boom would not have occurred and a major reason for the boom was a fast convergence of interest rates. The interest rates went up very quickly and in a way this was a shock to demand for loans but also for consequently for various other activities and led to much higher price increases in certain sectors. If these countries were outside the euro and there was a smaller euro crisis, the problems in 2008 would not have occurred and even if there were a problem, there would have been fewer problems. So clearly a smaller euro area would have been much stronger. This is now history and we have a euro area of 17 members and 5 southern countries and Ireland, which are in trouble, and we need to look at the options to handle the situation.

JP: Is the reason the Eurozone still kept completely political? ZD: Yes everyone recognizes that. It was largely dominated by a political process, which started in the Second World War, which was the bloodiest war of history, and European nations were fighting against each other so they realized that on the political spectrum they realized that a high level of integration would prevent this from happening again. The exterior countries realized that they were small and if they integrated on economic terms, they would be stronger together than individually. So there was a political incentive but also economic incentives. They created the single market, which was a major achievement even though it doesnâ&#x20AC;&#x2122;t function well. And also there were strong economic reasons for joining the monetary union and clearly the political reasons are still present. They wanted to involve all major countries even the southern ones like Greece show that the political incentives were stronger than the economic ones. Accepting members with economies that clearly did not meet the Maastricht Criteria was a

political decision.

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9.4.3 Mexican Ministry of Economics’ Mission to the European Union Interview with Mr. Barrera, Mr. Vanegas, and Mr. Gonzalez Bio: I interviewed members of the Mexican Ministry of Economics’ Mission to the European Union. I interviewed Roberto Reyes Barrera (Minister of Economics in the Mexican Ministry of Economics’ Representative Office in Europe), Giovanni Bravo Vanegas (Economic Advisor in the Mexican Ministry of Economics’ Representative Office in Europe), and Luis Ernesto Gonzalez (Economic Advisor in the Mexican Ministry of Economics’ Representative Office in Europe). Time: July 17, 2012 Time: 1:00p.m.-3:00p.m. Location: Nearby restaurant. Type of Interview: Panel questions to the group that we discussed over lunch

JP: What are your views on the current situation in Europe? All: It seems quite dismal at best. Europe is struggling with one of the biggest crises in history. It hit at a time where Europe was not completely integrated and was not ready for such a crisis. While one can never be ready for something of this magnitude, Europe was unprepared structurally to deal with this.

JP: What do you see in the European Union from a foreigner’s perspective? All: The European Union is an incredible organization. The fact that they are able to organize themselves and create the huge organizations that exists is commendable. However, it seems like there is a large and significant lack of cohesion between all the parties. There are many different opinions floating around and it seems as though no one agrees on anything.

JP: To me, it seems as if the EU can often be a power struggle. Since all of you are members of a foreign mission to the EU, what are your views on this? All: That is exactly the case. It seems as though the entire EU is simply a power struggle as to which nation will end up ruling Europe when it should not be that. While the European Union will never be a United States, it does need to unite in terms of long-term goals. Nations need to think about what will be better for Europe in the long-term over what will be better for Europe now.

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JP: Do you think that countries in Europe want to see the long-term benefits of the EU or are distracted by the current problems? All: The current situation is huge. The euro is in crisis, countries are defaulting or on the verge of it, and there seems to be no solution at hand. It is easy to see how one can be distracted by the current problems but that should not be an excuse.

JP: Do you think that the situation is bad enough to where countries would be willing to lose more sovereignty? All: We do not think that European countries want to forgo their current nationâ&#x20AC;&#x2122;s interests over the long-term benefits for Europe.

JP: How is Europe seen by other countries such as Mexico? All: The European Union is seen as an incredible force that has much potential but is currently not structured in a way in which it can take advantage of that. It is sadly not in a position of power currently. Europeans have noticed that while the euro and Eurozone were seen as major global achievements, now other countries are starting to wonder whether or not Europe will organize itself and be able to continue.

JP: Is there a chance of losing the euro altogether or diminishing the size of the Eurozone? All: There is a sentiment that the euro might vanish and that the Eurozone might completely dissolve but we do not think that will be the case. If a country is kicked out, international investors might fear that Europe will kick out other nations so it would be very costly to do so. However the disadvantages for Europe of losing a nation such as Greece would be much less than the disadvantages for the nation that gets kicked out.

JP: What is needed to get out of the crisis? All: In economics one speaks about rapid action. While any organization has inner and outer lags, the EU has huge policy problems. To get a doctrine voted, it takes an incredible amount of time. And for a situation involving economics such as inflation rates, GDP to debt ratios, and budgets this is not ideal. This sort of lag would be huge and legitimately unnecessary.

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JP: Will nations need to forgo more sovereignty? All: Yes, they will need to do so to completely unite and have common fiscal authority. However whether or not nations are willing to do so is questionable and the feasibility of this idea is quite frankly probably impossible.

JP: What is needed for Europe to get to the point where they will further integrate? All: The situation will have to get so bad that European nations will either leave the Eurozone or realize that they will need to further integrate. Europe has always been a slow process and in the past about 70 years, it has been incredibly difficult to pass each of the treaties. The fact that Europe has gotten this far is still impressive from an international point of view but to be a world power, Europe still has a few steps of integration left.

JP: Does your team think this is possible? All: Mexico and other nations want them to succeed. Sure, some nations such as the US might see the Euro as a threat to the dollar but still, a European default crisis is not beneficial to foreign nations. This recession is hitting hard and foreign nations want it to end.

JP: Thank you for meeting with me today. I know you are all busy and appreciate the time you took to help me out.

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9.4.4 Dr. Fabian Zuleeg Interview with Dr. Fabian Zuleeg-Chief Economist of European Policy Centre Think Tank

Bio: Fabian Zuleeg is Chief Economist at EPC, in charge of the Europe’s Political Economy Programme. He leads the EPC’s work in the Economic Policy Forum, working closely with decision makers in the European institutions. He is responsible for the EPC’s work on the Economic and Monetary Union, the European Single Market (in particular the Digital Single Market), European labor markets, the EU budget and PPPs, health and well-being, and environment and energy issues. His current work focuses on the economic and Euro crises, Europe’s economic future and the future sustainability of Europe’s economic and social models in light of challenges such as demographics. He is particularly interested in how European policy and economic governance can address Europe’s dual growth crisis: a low aggregate growth rate and growth divergence, increasing disparities between countries. Fabian regularly comments on current economic issues in the EU in the media. He also chairs and contributes to a wide range of debates, conferences and seminars and has researched and published widely on European economic and social policies. Location: Interview was conducted in the EPC offices at the Residence Palace in Brussels Date: December 17, 2012 Time: 11:09 p.m.-11:40 p.m.

JP: Can you tell me about the EPC and what it does? FZ: We are an independent think tank. We try to make EU integration work. We work on all aspects of EU policy-making recommendations.

JP: What is your role at EPC FZ: I am the chief economist, which covers economic, social, and political aspects.

JP: What are your thoughts of the voting process of the EU? FZ: Depends what the topic is. In some areas we don’t have unanimity. On the crisis, they are focusing on more intergovernmental ways of working. We see a

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predominance of either unanimity or virtual unanimity because when you have agreements for a new treaty, which is done by unanimity. On the crisis, we need to reflect that these are quite fundamental issues. Further integration might never move to majority rulings. In the end, a government will not transfer substantial sovereignty to the European level without being in the position to support it for each individual country so we could not imagine that because of a vote at the European level, a country is forced to transfer sovereignty. We have also seen a number of new developments. With the fiscal compact, there has been a move to take things outside of the European system because it is clear that the UK would not support the fiscal compact so in the end the fiscal compact just became an intergovernmental agreement between the Eurozone countries excluding the others from the process. We have also seen that in a number of areas, we have a buy-in process. The treaties are only binding on those who opt into signing it. That is something that we will see more in the future. If a number of countries ratify it, it comes into force but it doesn’t require ratification from everyone. We have also got more of what is an enhanced corporation. This is when a number of countries take forward policy areas. So that doesn’t require the agreement of all countries as long as you have a critical mass to go ahead. We will still see that and see a continuation of many areas that use qualified voting but when it comes to fundamental decisions, countries will only be bound by the things they have signed. Transferred sovereignty otherwise will not work.

JP: Should the EU relook the Maastricht Treaty or improve regulation of nations? FZ: The question of how you apply a set of fairly strict rules on the entire area is a big difficulty. The European integration process, the single market, has worked on legal convergence. We have the same laws being made which apply to all of the countries, which are in the Union. When it comes to something as rules, it is more difficult. How do you decide who fulfills them, plus there is some room for interpretation. When looking at economic data, what you find one year might be different another year. There was a rule in the commission for assessing the Maastricht Criteria but in the end it came down to whether the stronger states were willing to tell the other states that they would not be part of it because of the economic data. Strictly speaking, countries like Italy could not have been part of the Eurozone but that would have opened a number of questions because Italy technically did fulfill most of the criteria and when you look at the debt criteria, what was stipulated was that they were moving in the right direction. There was also the question of what you do with other countries, which also didn’t fulfill the debt criteria but was doing the right things to address it. The question could also be political. On what level could you exclude countries who wanted to be part and especially since countries like Germany haven’t seen it as an economic project, it has been a political country on the integration of Europe and frankly Germany at the time was not particularly stringent about the way it applied rules

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to its budgeting. It had a hidden budget financing its reintegration so it was politically tough to say no to countries. Now this has changed because we see what happens if we don’t say no. The lesson is clear. It is also very clear that the new governments’ mechanisms are stronger. We have the reverse majority. Ultimately you have to vote against allowing a country to enter which is more difficult. Fundamentally, there is still a big question at the heart of this. Or two big questions. One is the question of flexibility, what happens in the crisis. Who decides that under certain circumstances, it makes more sense to have looser rules than the ones stipulated? What happens if there’s another downturn and you need fiscal flexibility. That’s part of the question. And that is still very open. The other question for me is the question of what happens if it is not a relatively small country that breaks the rule but a relatively big country. What if it’s Germany or France? Will the same weight be applied to a country like France, which is very clear that they are an essential component of the EU? We will see if the rules will work for these kinds of players. In the long run, just rules won’t produce the outcome everyone wants. We can see that already by putting more and more pressures on countries like Greece and we are not seeing the reduction on debt that we want because the situation is disastrous. Instead we need to focus on the economic side, on growth.

JP: Is it possible to continue this fiscal union without a monetary union? FZ: Whether it’s possible or not is the big question but I think this is absolutely necessary. I don’t think there is any appetite for a federal European integration. That is not where the discussion is going. People are talking about what is necessary to make economic integration work. We know the current rules are not enough. We have a set of untested governance rules. I think there is a lot more which will have to be done. Some form of fiscal union, mutualization of debt is essential. The danger is that we are already doing it through the back door but we are not having the economic and political system to back it up. We have the central bank buying the debt of countries on secondary markets, which means that any default in these countries would hit the other countries but we are not getting the benefits from this process and talking about the disadvantages for the other countries. There would be lower interest rates so the costs of financing this would go down. This mutualization of debt can only happen if there are mechanisms to deal with the disciplinary issue. If countries know that if they don’t behave, there will be sanctions. The new rules go part of the way but aren’t enough to fulfill that. And the growth issue has to be addressed and employment has to be addressed. Without a real drive to ease the social issue in these countries, none of the reforms will be politically feasible. At the same time we have to deal with the banking system. A full banking union is necessary. If we have all that, we need a larger political union. Exactly how is undefined but you can’t have all these economic steps without more political union. Populations

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would not understand or condone that level of transfer of sovereignty without being involved but also from a very narrow political and legal point of view, countries like Germany have mentioned that they can’t go down this route much longer without changing the constitution and addressing some issues from the constitutional court in Germany. There will have to be larger political union. If you do this through the European parliament or direct elections, there has to be something to underpin the whole thing through democratic legitimacy.

JP: Are the constituents making it harder for political advancements to go through? FZ: The European integration is hard in good times because someone has to give something up even though the longer term gains are bigger in the long term than the disadvantages. These are the political elites so it is very difficult to move ahead. In this case it is even more difficult to move ahead because what we are talking about in these integration steps are some core things of economic governance: the power to budget, and make decisions on debts and deficits, which are some key issues of national governance. Transferring them will always be difficult. And it is difficult at a time when there is a loss of trust and a lot of painful decisions have to be made which are not understood by the constituents. But we have had a strong driver in the crisis. It has pushed a huge amount of integration already. My view is that the crisis is far from over and we will still see a strong push to further integration. What we have at the moment is an unstable equilibrium. We can’t stay where we are. Either we move towards further integration or we will risk fragmentation.

JP: Is there still a risk of fragmentation? FZ: Huge risk. We are going to see some degree of this in any case. We already have some issues around certain countries in the EU and how it works. The UK certainly doesn’t buy into any further integration. If anything, it wants to renegotiate its membership in the other direction. We have many views that might lead to some countries making different choices. But in the end the vast majority of countries will go towards further integration and yes there would be a real pity to loose some but some might be outside.

JP: So there is a greater chance that countries will choose to leave, such as England, than be forced to leave, as some say might happen to Greece? FZ: Yes. There is no real way of forcing a country to leave so it has to be the choice of the country. The risk is much higher for a country such as the UK

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because it is virtually certain that there will be a referendum in the UK and I think that this referendum will very quickly turn into a question about their membership. A renegotiation isnâ&#x20AC;&#x2122;t really on the table and if you have that referendum and which public opinion polls will suggest that they will be out, under the Lisbon treaty they can leave the union. No country can be made to leave so the chance is much higher that this will happen.

FZ: I have another meeting and have to leave. JP: Thank you for your time and comments.

9.5 Graphs Graph 1: Greek Debt compared to Eurozone Average

Source: Eurostat

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Graph 2: Current Account Balances – 2010

Source: CIA World Factbook

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Graph 3: Annual GDP growth – percentage change from previous year

Source: Eurostat

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Graph 4: Unemployment Rate

Source: Eurostat

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Graph 5: Government annual surplus or deficit

Source: Eurostat

Graph 6: Government debt as a proportion of GDP

Source: Eurostat

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Graph 7: European current account balances (% of GDP)