Lorenzo's Roadmap for EMU (and politics in general)

In a speech delivered for the Hellenic Foundation for European and Foreign Policy (Isle of Poros, 08/07/11), ECB member Bini Smaghi makes some very interesting comments on decision-making in times of crisis. This 7 pager is straightforward, not revolutionary but carrying simple truths and some good advice for politicians. Unfortunately Brussels overlooked it. Especially his analysis on political unions, the current accountability problems in a democratic framework and the enforcement of rules need a closer look. Some teasers out of his lecture of late Friday, very much underscoring the present problems and its roots :

"Recent experience has shown that tough decisions are often taken only on the brink of the abyss, when the fateful consequences of not taking such decisions become all too evident to governments and to those they govern. This creates at least five highly undesirable outcomes, in particular within the European context :

First, it increases uncertainty in financial markets about the course that will ultimately be followed...Second, the longer a decision is delayed, the more unpalatable it ultimately becomes, as the action required to calm the markets and to restore stability has to be even stronger...Third, by putting off difficult decisions until the very last moment, interim or partial solutions tend to be adopted, instead of more lasting ones. Crises then drag out as one quick fix gives way to another without the underlying weakness being addressed..Fourth, as the sequence of quick fixes proves to be ineffective in getting to the root of the problem, reform fatigue starts to spread and people become less willing to accept increasingly unpalatable measures. The result is a blurring of the difference between the negative but short-term impact of the necessary adjustment on the one hand and the disaster which would result from inaction on the other. This in turn increases the risk of taking the wrong – irrational – decision...Fifth, if people do not realize how close they are to the abyss, and thus do not support the adoption of the unpalatable decisions, policy-makers have to make them aware of the risks by appealing directly to them, which may in turn frighten and unsettle the markets".

Bini Smaghi moves a little bit further and makes comparisons with the US and the current market handling of double standards

"The current debate about the debt ceiling in the US, with some politicians openly speculating about a technical default, is a clear example of democratic decision- makers avoiding tough decisions until they are pressured to make them. Similarly, Lehman Brothers’ failure in September 2008 showed that waiting for too long on the brink of the abyss does not necessarily lead to the right decision. It showed, too, that the costs of a disaster are much higher than those arising from unpalatable decisions taken at an early stage. What makes the difference between the euro area and other cases is that failure to take prompt action in the latter is considered to be a policy mistake, even if it has dire consequences, but it does not call into question the whole institutional and political set-up. When Lehman Brothers collapsed and the US Congress initially voted down the TARP in September 2008, the dollar was not considered to be at risk. In Europe though, a crisis is sometimes considered by outside observers as putting the euro, and the Union itself, at risk of disintegration. Academics and other experts deliberate on whether the euro area is viable and how it can be rescued. Closet eurosceptics suddenly reappear, dusting off their I-told- you-so commentaries. And politicians feel compelled to restate their faith in and commitment to the euro and the Union. The issue is all the more surprising given that, overall, the euro area is progressively recovering from the 2008–09 recession, with some countries performing strongly. The average budget and deficit in the euro area is substantially lower than in other parts of the world."

And the paper offers more insights on how the political union currently operates, what is practically feasible in the short term to improve it and what still needs to be done. And Bini Smaghi concludes :

Winston Churchill said: “You can always count on Americans to do the right thing – after they’ve tried everything else”. The last 18 months suggest that Europeans, too, may do the right thing, after trying everything else. However, in today’s world, with sophisticated financial markets, deferring decisions creates uncertainty, entails substantial costs and may undermine the political cohesion of the Union. This is particularly the case when, as J.K. Galbraith observed: “Politics consists in choosing between the disastrous and the unpalatable”. To see disaster looming before choosing the unpalatable is a dangerous strategy... Europe’s undertaking has no precedent. It demands original thinking, as much as, if not more than, that of America’s founding fathers in their times. It certainly also demands their courage and leadership.

The 7 page speech can be found at

http://www.bis.org/review/r110712c.pdf