An old professor of mine dies

Bloomberg View reports: ‘Father of Euro’ Knew It Was a Problem Child:

The obituaries of Baron Alexandre Lamfalussy, the cosmopolitan banker who died May 9, describe him as the “father of the euro.” He led a rather charmed life, fleeing Communist-controlled Hungary as a young man, settling in Belgium, and ultimately becoming general manager of the Bank of International Settlements. A brilliant economist, he was the first president of the European Monetary Institute, the forerunner of the European Central Bank.

But many of the dutiful eulogies failed to note one of his central achievements. Even as he played a vital role in the creation of the monetary union, Lamfalussy understood the fatal flaw at its heart: the absence of fiscal and political union to hold it together. As the euro zone lurches toward another reckoning with Greece, his candid assessment points to the radical reforms that may be needed to ensure the survival of the euro.

As the Cold War ended, Jacques Delors, president of the European Commission, presided over an eponymous commission to craft a road map to a common currency. Delors deserves credit for seeing a golden opportunity to make the euro a reality in the near future. But Lamfalussy, who served on the commission, seems to have seen farther into the future.

The best account of the Delors Commission can be found in Harold James’s magisterial history of the euro. Lamfalussy comes across as profoundly skeptical of the idea that Europe could have a monetary union without a fiscal union. In the transcripts of the meetings, he dryly dismissed the idea “that market discipline was sufficient to bring about fiscal convergence.” He invoked history, noting that successful monetary unions like the one created by the U.S. in 1789 went hand in hand with a fiscal union.

Lamfalussy ultimately submitted an astute analysis of the problem to the larger committee. It laid out a diagnosis that remains relevant today. Lamfalussy contested the conventional wisdom that the financial markets could “iron out of the differences in fiscal behavior between member countries” by making profligate nations pay higher rates to borrow. 

This was unlikely to succeed, he wrote, because “the interest premium to be paid by a high-deficit member country would be unlikely to be very large, since market participants would tend to act on the assumption that the EMU solidarity would prevent the ‘bankruptcy’ of the deficit country.” 

He was right!

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