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A big problem with the eurozone’s one-size-fits-all monetary policy is that it risks fitting nobody. That, indeed, was a key cause of the crisis. Early in the century, countries such as Spain and Ireland were booming, while Germany was in the doldrums. Setting interest rates at a level that worked well for the eurozone on average had the effect of inflating the Spanish and Irish property bubbles while pushing up wages so their economies became uncompetitive. When the bubbles burst, the damage was devastating.
It would be hard to argue that any part of the eurozone is currently booming. Even Germany will eke out GDP growth of only 0.3% this year, according to the International Monetary Fund. But it may not be long before the problems of a one-size-fits-all monetary policy are back to haunt the zone. Even though the German economy isn’t growing strongly, it is still outperforming the average. What’s more, labour is in short supply in Germany and house prices are rising at a moderate clip—a big contrast to the average, let alone recession-inflicted countries such as Italy.
The European Central Bank’s policy of keeping interest rates at the current 0.5% level or lower for an ‘extended period’ is right for the eurozone on average. The weaker countries would benefit from even looser monetary policy. Germany, though, may already need something tighter. If the “extended period” of low interest rates goes on for years, it could experience a boom.
Many observers view one-size-fits-all interest rates as one of the zone’s design defects, about which nothing can be done. Others advocate policies—such as full fiscal union—which are not going to be adopted and wouldn’t really hit the spot even if they were. But the outlook isn’t quite so pessimistic. There are two policies that could mitigate considerably the damage of the single monetary policy—and they don’t even require any treaty changes.
The first is for eurozone countries to pursue vigorous ‘macroprudential’ policies. Since Lehman Brothers went bust five years ago, it has become fashionable to call for bank regulators to have the tools to prevent future bubbles. The main idea is