Delusional Germany

The second illusion that blinkers many Germans is that other European governments are after their money. As a result, Germany has been reluctant to engage fully in the debate about a European banking union, owing to the belief that it would expose German taxpayers to major risks and unknown costs through bank restructuring and deposit insurance. Similarly, Germans have been critical of the ECB’s monetary-policy instruments, especially its , with opponents appealing to the German constitutional court to invalidate the OMT scheme’s conditional purchases of eurozone government debt.

Such opposition seems counter-intuitive, given that the ECB’s mere announcement of the OMT program calmed sovereign-debt markets and reduced borrowing costs in peripheral countries. Indeed, simply by providing a credible backstop against the risk of a eurozone collapse, the scheme has become one of the most successful measures introduced by any central bank in recent history. The most reasonable explanation for Germany’s response is that many Germans harbor a deep mistrust of other European governments, and thus believe that they cannot be counted on to avoid insolvency.

Germany’s third illusion is that the current crisis is ultimately a euro crisis. While it is tempting to scapegoat the common currency, the fact is that the euro has brought huge economic and financial benefits to Germany, owing to increased trade, greater price stability, more competition, and improved efficiency.

Furthermore, the eurozone crisis does not have the characteristics of a currency crisis. The euro is not overvalued or poorly managed, which would undermine competitiveness and erode confidence in the currency’s long-term stability. On the contrary, the remarkable resilience of the euro’s exchange rate vis-à-vis all other major currencies demonstrates enduring faith in the euro’s viability and stability. What financial markets no longer believe is that governments will do what it takes to rescue Europe from the crisis.

The argument that the crisis stems from the eurozone not being an optimal currency area is similarly flawed. No economy is an optimal currency area; there are substantial differences among US states and even across Germany’s Länder. The main challenge to the euro’s long-term viability is the lack of political will to implement complementary policies, such as a banking union and a credible fiscal union.

While the eurozone economy’s outlook has improved, it is not out of danger. A deep crisis in any member country is likely to become contagious. Given Germany’s trade and financial openness, as well as the leadership responsibility that accompanies its economic strength, it would face particularly high costs.

Against this background, Chancellor Angela Merkel’s third government, once it is formed, must rid the country of the illusions that are preventing it from playing a proactive and constructive role in ensuring that Europe functions as a union. Such an undertaking requires, above all, the restoration of trust among European countries. While that will undoubtedly be difficult to achieve, it is Germany’s only real option – and Europe’s real hope.

Marcel Fratzscher is President of the German Institute for Economic Research (DIW Berlin) and Professor of Macroeconomics and Finance at Humboldt University Berlin.

Copyright: Project Syndicate, 2013.