Peterson Institute for International Economics Update Newsletter
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PIIE Update Newsletter
August 9, 2012

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  Policy Brief 12-20
Why a Breakup of the Euro Area Must Be Avoided: Lessons from Previous Breakups

Anders Åslund
  Anders Aslund One of the big questions of our time is whether the Economic and Monetary Union (EMU) will survive. Analysts too often discuss a possible departure of one or several countries from the euro area as little more than a devaluation, but Åslund argues that any country's exit from the euro area would be a far more important event with potentially odious consequences. A Greek exit would not be merely a devaluation for Greece but would unleash a domino effect of international bank runs and disrupt the EMU payments mechanism, which would lead to a serious and presumably mortal disintegration of the EMU. It would inflict immense harm not only on Greece but also on other countries in the European Union and the world at large.

When a monetary union with huge uncleared balances is broken up, the international payments mechanism within the union breaks up, impeding all economic interaction. Åslund's critical argument for a domino effect is that the EMU already has large uncleared interbank balances in its so-called Target2 system. Exit of any country is likely to break this centralized EMU payments mechanism. These rising uncleared balances are a serious concern because nobody can know how they will be treated if the EMU broke up. Any attempt to cap them would risk disruption of the EMU. These balances need to be resolved but in a fashion that safeguards the integrity of the EMU. However, this can hardly be done by anything less than fully securing the sustainability of the EMU. If the euro area does break up, Åslund says, the damage will vary greatly depending on the policies pursued. On the basis of prior dissolutions of currency zones, such as the ruble zone in 1992 and 1993, he suggests that an amicable, fast, and coordinated end of the EMU would minimize the harm.

>> Read full policy brief [pdf]

  Congressional Testimony
Challenges of Europe's Fourfold Union

Nicolas Véron
  Nicolas Veron Europe's insufficient ability to make authoritative policy and political decisions for the region as a whole lies at the core of the current euro area crisis. This "executive deficit" is compounded by Europe's much-analyzed democratic deficit, as leaders do not have an adequate democratic mandate to take the necessary action. To correct this weakness, Europe must build a fourfold union that would allow such executive decisions to be made. The four components are: (1) a banking union, (2) a fiscal union, (3) a competitiveness union, and (4) a political union, i.e. institutional reform to embed democratic accountability more solidly in decision making. This entails profound changes to Europe's institutional framework. The European Parliament in particular must become more representative and exert more direct control over policymaking. The four components of banking, fiscal, competitiveness, and political union will take several years to be completed. They are mutually interdependent and must be taken together, ideally in parallel increments. Achieving this fourfold union is indispensable to avoid euro area breakup, which would be disastrous for Europeans and the global economy. It is not too late: The current trend towards fragmentation of Europe's financial, economic, and social space is damaging and worrying, but it has not reached a point of no return.

>> Read full testimony
>> See additional testimony on the euro area from Simon Johnson

The International Economy in 2011

John Williamson
  John Williamson The middle of 2011 marked two years since the start of the current recovery. The dominant fact about this recovery is that it has been led by the emerging markets rather than by the so-called advanced countries, most of which have at best remained with excess supply, a positive output gap, and a slow rate of growth, and at worst are dominated by continuing crisis. Indeed, most developing countries and not just those usually now referred to as "emerging markets" (those developing countries that have achieved regular access to the international capital market) have been growing faster than the advanced (or developed) countries during the present upswing. Many believe that this is the start of a historical trend that is likely to persist unless and until the world is consumed by the threat of climate change.

>> Read full paper [pdf]

Peterson Perspectives Interviews

audio  Greece Should Not Quit the Euro Area, Part II
Anders Åslund explains that a Greek exit from the euro would produce chaos and bank runs throughout Europe and inevitably lead to a breakup of the euro area itself.

audio  Greece Should Not Quit the Euro Area, Part I
Anders Åslund explains why Greece would invite far more troubles to its economy from quitting the euro area than from staying in it and reforming.

audio  Europe's Quest for a More Perfect Union, Part II
Nicolas Véron describes the executive and democratic "deficits" that have prevented swift decision making and crisis intervention in Europe.

audio  Europe's Quest for a More Perfect Union, Part I
Nicolas Véron explains why Europe must strive for greater union on four fronts all at once—political, fiscal, competitiveness, and banking.

audio  Power Blackout in India, Part II
Arvind Subramanian says that the recent power outage in India symbolizes the country's deeper problems of poor infrastructure, corruption, and profligate use of subsidies for those who should be paying for their energy.

audio  Power Blackout in India, Part I
Arvind Subramanian explains that the massive power outage in India resulted from several factors, including a bad monsoon and heightened power usage in the northern farm belt.

Recent Blog Posts

RealTime Economic Issues Watch   China Economic Watch    North Korea:  Witness to Transformation
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The IMF Embraces FEERs and Acts to Broaden Surveillance

Can India's Power Problems Be Solved?

Will Venezuela's Entry Be Mercosur's Swan Song?

Reflections on the Situation in Greece

Recent Euro Area Developments Clarify the Road Ahead
  Investment Above All

China's Recent Financial Reforms: More than the Sum of the Parts?

China's Wild West Interest Rate Liberalization

The Chinese Growth Model: Before and After the Crisis

Financial Repression and the One-Child Policy
  Nigeria scams North Korea. Or vice versa.

Summer Reading IV: Kwon and Chung's North Korea: Beyond Charismatic Politics

Not Satire: US Concerned About DPRK Money Laundering

The "June 28 Directive" and July 26 "Let us Effect Kim Jong Il's Patriotism...": Not Yet Time to Break out the Soju

Legalize it.

PIIE Noted in the News and on the Web

China Could Slow for Several More Months
Nicholas R. Lardy explains how weakening industrial production, housing investment, and new residential construction may indicate several more months of slowing growth in China.

Preview of Our Next Issue

Congressional Testimony
The Future of the Euro Area: Outlook and Lessons
Simon Johnson

Working Paper
Sovereign Debt Sustainability in Italy and Spain: a Probabilistic Approach
William R. Cline

The Fairness Paradox
Gary Clyde Hufbauer

In This Issue

Featured Book
Title Resolving the European Debt Crisis
William R. Cline
Guntram B. Wolff

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