Nothing is easier than pointing fingers at policymakers working feverishly at 2 a.m. to contain a rapidly spreading financial crisis. Rarely has this been truer for the European Union than during the current crisis’s amateurish policy management. Yet, what really matters is the final result, which is far more positive for Europe than the ugly sausage-making process.

In this policy brief I take the premise that the current European crisis is principally fiscal in nature and argue that during the weekend of May 8–9, 2010 European leaders crafted a very important and constructive political “grand bargain” between EU member states and the European Central Bank (ECB) with far reaching, positive implications for the credibility of the European Union’s fiscal policy framework and the long-term sustainability of European government finances.

I further illustrate that if Greece is ultimately forced to default on its debts, it is certain the Greek government would want to do it within the eurozone. As such, a Greek default poses no risk to the composition of the eurozone, which considering that a German departure is equally unlikely is a secure monetary union. I conclude with a set of required next steps for Europe.

Europe’s Crisis Manageme nt Preventing financial crises from spreading always requires decisive action from policymakers and a “big number” to completely dispel financial market’s uncertainties about the political will to act. The reason for this is simple. To function, financial markets require something to disagree on. There must always be two sides to a trade, and for transactions to take place (and price volatility to emerge), buyers and sellers need to disagree on the price of an asset.

However, in a financial crisis, invariably characterized by herd-like behavior by financial-market participants, everyone becomes convinced about the imminent financial collapse of companies, banks, or even countries. As such, policymakers need to put together “an overwhelming official response” to change the minds of a sufficiently large number of market participants to stabilize asset prices.

Unfortunately for Europe’s ability to act in a financial crisis, EU institutions are, as a direct result of their unique regional supranational composition, extremely ill-suited to produce a “decisive response” to communicate to financial ...

Read Full: In Defense of Europe's Grand Bargain

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Jacob Funk Kirkegaard
Peter G. Peterson Institute for International Economics

Jacob Funk Kirkegaard is a research fellow at the Peterson Institute for International Economics. Before joining the Institute, he worked with the Danish Ministry of Defense, the United Nations in Iraq, and in the private financial sector.

He is a graduate of the Danish Army’s Special School of Intelligence and Linguistics with the rank of first lieutenant; the University of Aarhus in Aarhus, Denmark; and Columbia University in New York.

He is author of The Accelerating Decline in America’s High-Skilled Workforce: Implications for Immigration Policy (2007) and coauthor of US Pension Reform: Lessons from Other Countries (2009) and Transforming the European Economy (2004) and assisted with Accelerating the Globalization of America: The Role for Information Technology (2006).

His current research focuses on European economies and reform, pension systems and accounting rules, demographics, offshoring, high-skilled immigration, and the impact of information technology.

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