Will that flexibility though be assured to every member of the Euro-zone, or is it just something imposed by the larger countries because they can?
Well, again that's a good question. The fact that France and Germany did it, hopefully opened the door for all the other countries. It forced the commission to address the fact that you couldn't stay forever trapped in a monetary straitjacket, you couldn't pretend that there wasn't a real economy out there. It was necessary for them to do that in the initial stages, because had there been a soft Euro, or had there been an indication that the European Central Bank would not seek to enforce inflation targets I think the currency could have got off to a very rocky start. That credibility is now established. We have the Euro, the Dollar, Sterling and the Yen. That new paradigm has now been established
Because France and Germany are the bigger countries, they've imposed that flexibility on monetary policy which underpins the single currency; it does open the way for greater flexibility for all other countries. And the commission will just simply have to come to terms with a new approach, a new set of guidelines, new rules that all countries can live with.
Well that does cause problems. It does create a fundamental problem along these lines:
if you consider all of the different States in America, you have a single currency, the dollar, you've a single monetary policy, which is agreed on by the fed. Now that single monetary policy will not accommodate itself to all of the States in the union. Some of the States will be suffering high unemployment, and will need lower interest rates, other things being equal, some of them may be under employment pressure and you'll find inflation rising. Now what America has is something called fiscal federalism, which in other words – the federal authorities have a budget of perhaps 7 or 8% of America's GNP and it can use this fiscal federalism as it's called to smooth out conditions in individual States that are under pressure, through fiscal transfers. We however don't have that in Europe. Yet
It's the biggest single piece of architecture that's missing. Unless and until the European Central bank and the European Parliament and so on and so forth get together a federal budget where it can use fiscal transfers to countries where ,say, the single monetary policy is not appropriate, where it may be too over rigid, there will still be a deficit there. We simply have to put in place a larger fiscal facility that allows the European Central Bank to assist those countries or regions that are having real problems with a tough single monetary policy regime. So there is some work to do there.
There is however a lot of work to be done in terms of a single European system of financial supervision. The reality is that even though we have a single currency, and even though that single currency is transmitted throught the single currency institutions and markets we still don't have a single regulatory authority to which these markets and institutions are responsible. That's a key point. You can't really have a single currency and a single monetary policy, working through that currency, and working through banks and markets in different countries and yet not have the European Central Bank having control over those markets and institutions. At some stage, the control that National authorities have, which was purely the result of late nights in smoke filled rooms, when they were negotiating the Maastricht treaty, they decided to leave control in the hands of individual countries. That's no longer feasible and it does pose significant latent dangers to the European financial system. We need a European Central Bank that has strong European Central Bank regulatory and supervisory powers.
That’s a political hotcake though, isn’t it? Will countries be prepared to take that on?
Well, countries are often kind of jealous of holding on to powers, and some people would say that it's better kept within their own country control, but remember: we have a single Euro land now. We have a group of almost 30 countries in which the Euro will be currency and it will operate in different banking, securities, and insurance markets. All of those are potentially vulnerable to systemic risk. We’ve seen risk in America , we've seen risk in South East Asia at the end of the 1990's, we live in a globalized economy where risk is transferred almost like a lightning conductor. And I would be seriously concerned as a former central banker at the lack of an integrated regulatory authority for all of the Euro area rather than the patch work of ad hoc arrangements that have been put in place currently –it's not sustainable, it couldn't withstand a major crisis and it will have to be addressed.