The political economics of the euro

The history of past real or quasi monetary union of sovereign states suggests that the build-up of severe fiscal imbalances in parts of the union and the monetisation of these deficits have been the key reasons for failure. In order to return EMU to a stable, contractually founded base it seems necessary that governments either take a significant step forward towards a political union – which is very unlikely in our view – or restore the two key pillars on which EMU was built, namely the principles of the central bank’s exclusive focus on the purchasing power of the common money and governments’ full liability for their financial decisions. In the light of the recent momentum in the political debate we would give such an outcome over the coming 6-12 months the highest probability and it is likely be driven by grass-root events. Alternatively, if the political elites remain in control and enforce the continuing execution of unviable adjustment programmes, we see a significant risk of an eventual break-up of EMU.