Joseph Stiglitz On How to Save the Eurozone

LONDON -- The European Union's single currency, the euro, was conceived in 1992 -- and began circulating in 2002 among 19 of the 28 EU members -- to deliver economic prosperity and political unity. Instead, during the past decade, the eurozone's been buffeted by debt crises, economic stagnation and rampant joblessness. It's fostered more disharmony than solidarity. Nobel Prize-winning economist Joseph Stiglitz's new book, "The Euro: How a Common Currency Threatens the Future of Europe," looks at what ails the monetary union, and offers possible cures. He spoke with contributor Thomas K. Grose.

You write that the euro was a flawed construct from the start because it was based on neoliberalism, or unfettered free markets. Why was that a fault?

Part of the basic doctrine was that markets on their own would quickly achieve full employment and efficiency if you only got government out of the way. The main responsibility of the government was to make sure there wasn't inflation, and to maintain budgetary balance. Membership also placed restrictions on government deficits and debt. Markets were supposed to quickly equilibrate to full employment. You took away the exchange rate? That wasn't a big deal; markets could handle that.

Well in fact, markets couldn't. Markets can also exhibit irrationality. So money rushed into places like Spain causing inflation, prices rising relative to that in other countries. The only way to correct that was to bring down the prices, relative to Germany. Germany refused to increase its prices, so that meant there had to be deflation in Spain (and in other countries). And deflation is very hard for countries. When people borrow money, they have to pay it back in (euros) that are worth more. The single currency not only made it difficult for them to adjust to shocks, it created its own disturbances to which it could not adjust.

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Also, there's no federal government to handle transfer payments, automatic assistance like unemployment insurance, during downturns.

Germany has said very strongly: "We're not a transfer union." If the United States were not a transfer union, we would not have bailed out Washington Mutual, we would not be sending money to Mississippi, we wouldn't be a nation. They wanted this very peculiar halfway house where they didn't provide even this kind of minimal help in times of need -- a sort of mutual insurance. There were many other ways of creating integration besides a single currency. That should have been at the end of the journey, not the beginning. Before they began the journey they should have put into place a whole set of other institutions that were absolutely necessary to make it work -- things like a common banking union, common deposit insurance, a solidarity fund for stabilization (to provide fiscal stimulus in downturns).

Your main proposal is to put these institutions -- including a banking union, mutualization of debt and a solidarity fund -- into place now, better late than never. What else needs to be done?

Countries that have trade surpluses need to take stronger actions to inflate their economy relative to the weak ones. Surplus countries are imposing a cost on weak countries. If Germany insists on having a surplus, that means that others have to have deficits. Trade deficits cause problems. To correct that, Germany has to increase its prices relative to, say, Spain. Deflation is very costly; mild inflation is not that costly. If Germany has a 3 (percent), 4 percent inflation rate for a few years, it would correct the problem.

Another option you suggest is a "flexible euro" -- where individual countries, or groups of countries, each have their own euro. How would that work?

You could go back to where you had 19 currencies, or you might have two or three currencies. The flexible euro is a way to keep the flame of the single currency alive. I show some ways you could limit the extent to which the exchange rates vary, so you keep them fairly much in line, but not with the rigidity that they have today. You work on creating the institutions I described, and over time, if you prove that you could actually manage the system so that the exchanges were very close to stable, then you would have also proved you have created institutions that would make the euro work.

Instead of embracing needed reforms, how likely is it that the eurozone will continue to muddle through, as has been the case?

Increasingly I think that muddling through is not going to be a viable option. There's a likelihood of increasing disillusionment with the center-left, center-right parties that have been supporters of the euro. And the extremist parties, all of whom agree that the euro is the wrong policy -- either because of extreme nationalism or because of the continuing commitment to austerity -- will become dominant.

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So it could all fall apart?

If, in one country or another, a party advocating an exit referendum started looking like it was going to win an election, where it's clear that a referendum would almost surely lead to a departure, like Brexit, capital markets would possibly respond with even more of capital flight than we've had so far. That would lead to banking crisis. And the resulting political and economic dynamic would make a breakup almost inevitable.