Joseph Stiglitz: 'The EU's monetary union was the mistake'

“Yes, it’s a fair summary”, he says, “except for one thing. One of the arguments I make for the failure of the euro is that at the time it was being constructed there was a “neo-liberal” ideology which said that all we need to do to make this thing work is to get deficits low, keep inflation low and take down barriers and then everything would be fine.

"That was a very conservative ideology,  that if you did those things the markets would on their own adjust and everything else would come right. Not all right wing conservatives thought that, but a lot of what I call 'market fundamentalism' did go into the thinking on the euro."

But most of those in Britain who thought the euro a mad idea were on the political right, I point out. 

Stiglitz says that he is not really talking about the issues of national sovereignty raised by the euro. “I was thinking more in terms of the macro-economic adjustment. It is the absence of any proper economic adjustment mechanism which is the over-riding failure in Europe. Where the left and right would agree - and this speaks to the whole Brexit debate - is that Europe needs economic arrangement that work well for a very diverse group of countries.

"This requires a balance between flexibility and harmonisation, and in opting for monetary union they didn’t get that balance right. We see the lack of it particularly in the rigidity that Germany imposes on the eurozone’s crisis hit countries”.

The theme of Stiglitz’s book is that monetary union was basically where it all went wrong for the European Union. A project that was meant to bring countries together has succeeded only in tearing them apart in a manner which now threatens wider European economic and social stability.

“There have been other things that Europe got wrong, but monetary union was the overarching macro economic mistake. We can see this most clearly in the fact that some countries not in the euro but with the same regulatory framework, such as the UK and Sweden, did much better.”

So what, fundamentally, is the problem with the euro? 

“For the first nine years up until 2008 there were no symptoms, or no obvious ones, of how dysfunctional things really were. But actually the euro was already creating its own problems.

“When the financial crisis hit, it was roundly blamed on the US, but in fact a very large part of Europe’s crisis was created by the euro.

“The single currency gave markets this excessive confidence. They began to confuse the absence of exchange rate risk with the absence of risk per se. Monetary union had taken away the ability of individual governments to curb domestic inflationary pressures, which led to an increase in price levels relative to Germany. Real exchange rates became out of line. 

“One of the key points of the book is that it is easy to create these imbalances, made possible by the easy flow of money between countries under  the euro, but with a rigid exchange rate it is very hard to undo them. 

“There are only two ways of doing it. Have Germany inflate, or have the others deflate. Germany was unwilling to inflate. But deflation doesn’t work easily either because your debts are still owed, and that means that in forcing countries to deflate you make them even more fragile”.

We move onto the issue that most puzzles Anglo-Saxon commentators such as myself; if the euro is so bad, how come it has lasted so long?

“Well, you have to take account of the eight or nine years before the problem became apparent. Then there was ‘oh it has worked for nine years’ - even though it hadn’t - ‘so the crisis will be over quickly and we can make it work again’. When you have already invested heavily in something, it is very difficult to cut your losses. There is always a tendency to think that with just a little more investment, it can be made to work.

“So the politicians said, just accept a little bit of temporary pain and everything will be OK again. After two years that wasn’t true. And time and again it turns out not to be true. Good money is constantly thrown after bad. 

“Imagine yourself in the position of a Greek politician, with 25pc unemployment and an escalating financial commitment as a result of the fight to stay in the euro. As things go more and more wrong, you become ever more committed to the policy that got you there because to admit you are wrong is to say we have suffered all this pain for nothing”.

Does this mean Europe is essentially damned, I ask?

“The most likely scenario is a continued muddling through, which is what they have been doing to date. But neither Frankfurt nor Brussels controls events, as the Brexit referendum vote shows, so what you see – and this is not for sure but almost predictable – is growing alienation. 

“This is already apparent in electoral outcomes. More than 60pc of people in Spain, Greece and Portugal voted against austerity parties. The same thing with Brexit, which was also a rebellion against the political centre. 

“The only thing that saves the centre ground is that the anti-establishment movement is divided between left and right. So you get a stalemate which is also not at all good for anyone, and out of that who knows what happens.

“Getting a political coalition in any country large enough to leave the euro is therefore difficult. What’s so troubling is that it is also proving impossible for Europe to agree on policies to fix the euro, so you have neither one thing or the other. Despite his apparent pessimism, Stiglitz is not short on suggested solutions. 

“If you had a group of people sitting around a table rationally discussing the future of Europe, these are the sort of things they might come up with. 

“One is to say let’s finish the job. The US shares a common currency among 50 diverse states, so what are the institutions and rules needed to make the single currency work. 

“As a bare minimum, you need common deposit insurance, a banking union, Eurobonds, maybe industrial policies to allow those at the bottom to catch up, you need to move away from just inflation targeting, and you need some way of adjusting real exchange rate that doesn’t involve internal devaluation.

“Germany has to perform its role of allowing its economy to inflate relative to others. So those are the minimum to make a euro that works.

“But Germany takes the view that we are not a transfer union and we won’t even take the risk of a banking union or of common deposit insurance. This is like New York saying we don’t want to have federal deposit insurance because there is a bank in Alabama which might go bankrupt.”

If completing the job proves impossible, says Stiglitz, that leaves the alternative of an “amicable divorce”.

“In the book I use the example of marriage councillors. In the past, the job of the marriage councillor was to keep the marriage together, but modern ones sometimes say you should never have got married in the first place. 

“Once you have accepted the marriage can’t be made to work, then the only issue is how to make splitting up go as smoothly as possible. 

“In the book, I describe some novel ways of doing this. The core of the idea is that you are going to have to allow redenomination of debt, and allow some form of bankruptcy.

“A third way is the flexible euro where you say lets try and consolidate the institutional advances we have made but recognise that we are not anywhere near a single currency yet. And then I describe some mechanisms that would allow the exchange rate to be operated flexibly and allow economic adjustment”.

So what are the chances of any of these “solutions” being adopted, I ask.

“I’m hopeful”, Stiglitz says with a grin, which somewhat suggests he’s not.