The Euro and the Battle of Ideas

Markus K. Brunnermeier is the Edwards S. Sanford Professor of Economics at Princeton University and director of Princeton’s Bendheim Center of Finance. Harold James is professor of history and international affairs and the Claude and Lore Kelly Professor of European Studies at Princeton University. Jean-Pierre Landau is former deputy governor of the Banque de France and associate professor of economics at Sciences Po in Paris.

1 Introduction 1

PART I: POWER SHIFTS AND GERMAN-FRENCH DIFFERENCES

2 Power Shifts 17

Lethargy of European Institutions 18

The First Power Shift: From Brussels to National Capitals 20

The Second Power Shift: To Berlin-Paris and Ultimately to Berlin 27

After the Power Shift 33

3 Historical Roots of German-French Differences 40

Cultural Differences 41

Federalism versus Centralism 43

Mittelstand versus National Champions 48

Collaborative versus Confrontational Labor Unions 51

Historical Inflation Experiences 54

4 German-French Differences in Economic Philosophies 56

Fluid Traditions: Switch to Opposites 56

German Economic Tradition 59

French Economic Tradition 67

International Economics 74

PART II: MONETARY AND FISCAL STABILITY: THE GHOST OF MAASTRICHT

5 Rules, Flexibility, Credibility, and Commitment 85

Time-Inconsistency: Ex Ante versus Ex Post 86

External Commitments: Currency Pegs, Unions, and the Gold Standard 89

Internal Commitments: Reputation and Institutional Design 91

Managing Current versus Avoiding Future Crisis 94

6 Liability versus Solidarity: No-Bailout Clause and Fiscal Union 97

The No-Bailout Clause 98

Fiscal Unions 100

Eurobonds 111

Policy Recommendations 115

7 Solvency versus Liquidity 116

Buildup of Imbalances and the Naked Swimmer 117

Solvency 118

Liquidity 119

Crossing the Rubicon via Default 125

Sovereign-Debt Restructuring and Insolvency Mechanism 126

Fiscal Push: Increasing Scale and Scope of EFSF and ESM 127 Monetary Push 131

Policy Recommendations 133

8 Austerity versus Stimulus 135

The Fiscal Multiplier Debate 137

The Output Gap versus Unsustainable Booms Debate 143

Politics Connects Structural Reforms and Austerity 145

The European Policy Debate on Austerity versus Stimulus 148

Lessons and Policy Recommendations 153

PART III: FINANCIAL STABILITY: MAASTRICHT'S STEPCHILD

9 The Role of the Financial Sector 157

Traditional Banking 159

Modern Banking and Capital Markets 162

Cross-Border Capital Flows and the Interbank Market 166

10 Financial Crises: Mechanisms and Management 173

Financial Crisis Mechanisms 175

Crisis Management: Monetary Policy 185

Crisis Management: Fiscal Policy and Regulatory Measures 194

Ex Ante Policy: Preventing a Crisis 206

11 Banking Union, European Safe Bonds, and Exit Risk 210

Banking in a Currency Union 211

Safe Assets: Flight-to-Safety Cross-Border Capital Flows 222

Redenomination and Exit Risks 226

Policy Recommendations 233

PART IV: OTHERS' PERSPECTIVES

12 Italy 237

Battling Economic Philosophies within Italy 237

Mezzogiorno: Convergence or Divergence within a Transfer Union 239

Italy's Economic Challenges 242

Politics and Decline 245

13 Anglo-American Economics and Global Perspectives 249

Diverging Traditions 251

The Politics of Looking for Recovery: The United States 261

The Politics of Thinking Outside Europe: The United Kingdom 267

The Global Perspectives: China and Russia 279

Conclusion 286

14 The International Monetary Fund (IMF) 287

The IMF's Philosophy and Crisis Management 289

The IMF's Initial Involvement in the Euro Crisis 295

The IMF and the Troika 300

A Change in the IMF's Leadership 304

Loss of Credibility: Muddling Through, Delayed Greek PSI 306

15 European Central Bank (ECB) 313

The ECB before the Crisis: Institutional Design and Philosophy 315

The ECB's Early Successes and Defeats 325

The ECB and Conditionality 331

Lending and Asset Purchase Programs 343

Single Supervisory Mechanism (SSM) for European Banks 368

Taking Stock: Where Does the ECB Stand? 372

16 Conclusion: Black and White or Twenty-Eight Shades of Gray? 375

Acknowledgments 391

Notes 393

Index 427