Martin Wolf (2012): The German Response: “Mr Ludger Schuknecht: ‘Sir, Martin Wolf…

…voices a fundamental critique of the European fiscal and economic policy strategy in the context of the current debt crisis. He argues that the “eurozone is now on a journey towards break-­up that Germany shows little will to alter”…. Mr Wolf’s solution for the current problems is risk transfer via eurobonds (of some sort), and demand stimulation via cheaper money and less fiscal consolidation in Germany. But the public and markets have been led to believe in short-­term measures for far too long. And they know there is too much moral hazard already. Eurobonds would only make it worse and the healthier countries–mainly Germany and France–cannot even afford them.’…

The aim is not risk transfer, but rather substantially to reduce the problems members of the currency union now have in retaining liquidity in their sovereign bond markets. Mr Schuknecht argues that such multiple equilibria are impossible. There is good reason to believe he is wrong…. I do not know what ‘short-term measures’, Mr Schuknecht is referring to. But the public presumably expects the eurozone at least to hit its inflation target. At present, there is good reason to doubt that it will….

‘Moral hazard’ is not the clincher Mr Schuknecht believes it is. We have fire brigades, despite moral hazard, because it is bad for the neighbourhood for a house to burn down….. Deep economic collapses are very dangerous. Mr Schuknecht, with his emphasis on the long term, completely ignores these dangers.  If trying to avoid such a dire outcome is ‘short-termism’, so be it. I think of it as trying to find a practical exit from the current trap. Without it, the eurozone may never reach the long term…”