Target 2 imbalances within the Eurosystem have continued to grow during 2020. Currently Germany is owed Eur 1TN by the other countries, principally Italy and Spain. If Germany at some point insists on redressing these balances, is the collapse of the Euro inevitable?

  • $\begingroup$ I am sorry but this should be closed as opinion based/off topic. 1. There is no economics that will tell you at what level Germany becomes uncomfortable with that. Even if they would be greatly economically loosing that might be worth while for them politically - a topic on which economists are not qualified to opine and probably better question for political scientists. 2. I can’t see any way how this could be answered with anything but opinion. This would require quantifying perceived political benefits Germany believes it is getting by subsidizing Southern Europe. $\endgroup$ – 1muflon1 Jan 31 at 10:26
  • $\begingroup$ Thanks, those are exactly the issues I am interested in. Let me edit the question to focus on the economics. $\endgroup$ – dm63 Jan 31 at 11:50

Although possible it is not necessary for several reasons.

  1. Optimal currency area (OCA) can in principle exist even without fiscal transfers/excessive borrowing if there is perfect factor mobility within the OCA that can absorb the asymmetric shocks that countries in the monetary union face (see De Grauwe Economics of Monetary Union).

In the European Monetary Union (EMU), at a present, the factor mobility is not perfect because while there are no direct legal restrictions on movement of capital and labor it is not easy for people to move due to language barrier and poor integration of social security at EU level. However, as time progresses we see English becoming world-wide lingua franca. For example, in the Netherlands (where I live) a reasonable EU citizen can live and work never learning to speak Dutch in virtually any industry that does not require direct contact with consumers. All government forms and interactions are in both Dutch and English, and the same holds for doctors, and virtually all retail/service businesses. This significantly lowers barriers to labor mobility. In addition all the social security systems are getting more and more integrated within EU. For example, when it comes to healthcare the system in EU is already integrated in a way that switching is not a hassle but same does not hold for pensions.

Since we are talking about some unspecified future it is possible that at that time the labor mobility will be sufficiently perfect that any shocks can be absorbed via labor mobility and mobility of other factors as well. Indeed, if in past there would be no implicit restrictions on people moving from one EMU country to another, instead of fiscal transfers you would see large flow of people that would eventually correct the imbalances.

  1. Germany presently sends fiscal transfers to the Southern Europe because it was fortunate enough to experience positive productivity shocks while southern Europe experienced negative ones. I am not trying to minimize the role of good governance and policy in German robust productivity and also economic growth in recent decades, but no matter what policy this is to a significant extent also driven by random technological (where I am using the word in broad economics sense) or other macroeconomic shocks. Even the best govern country can't do much about that. In addition, random demand shocks or even monetary policy (e.g. low interest rates for too long) is also one of the issues that can contribute to macroeconomic imbalances that necessitate fiscal transfers (Pierluigi, Sondermann 2018; Blanchard and Giavazzi 2002; Lane and Pels 2012; Chen et al 2012).

Since we are discussing the future it is entirely possible that in 10 or 20 years Germany will be the country experiencing negative productivity/demand etc shocks while southern countries will be experiencing positive ones, as often macroeconomic shocks can be asymmetric. If the Germany starts insisting that South redressing its debt/fiscal transfers imbalances to Northern countries at that point in time - when it is from macroeconomic perspective optimal for South to actually do so, it won't cause any problem for the Euro, if anything it would be the optimal response.

  1. Euro, is not just economic but also political project. In principle, even if Germany does not want to send fiscal transfers or lend to southern countries, if ECB conducts monetary policy in a way that addresses only macroeconomic shocks in countries experiencing negative shocks (which in case of asymmetric shocks would be at an expense of countries not experiencing negative shocks), or if EU leaders decide they are fine with living with financially instable EMU it is still possible to keep the euro.
  • $\begingroup$ Thanks, I’ll be interested if anyone can reasonably rebut that argument. $\endgroup$ – dm63 Jan 31 at 14:01
  • $\begingroup$ @dm63 which argument you have in mind? 1 and 2 are just general well known results from economics of monetary union/macro very well supported by empirics - there is not much rebutting to be done there at least not within mainstream economics - and I would not even considered it an argument but rather statements of scientific facts. 3. Is an argument but also is less about economics than acknowledging that for better or worse euro is not about economics. If it would be about economics it would never be adopted in the first place (at least not ahead of fiscal Union). $\endgroup$ – 1muflon1 Jan 31 at 14:07
  • $\begingroup$ Well, (a) will sufficient labor mobility ever occur in the Euro area (b) given enough time will the transfers naturally reverse and (c) will Germany have the political will to continue with the current system. The last one is not economics. $\endgroup$ – dm63 Jan 31 at 14:39
  • $\begingroup$ @dm63 regarding a) that is one of the main stated goals of EU, and empirically there is a trend toward greater and greater labor mobility. I don't think there question is if, but when. That would be a good question, but since we are talking about unspecified future it does not matter for an argument. b) The target 2 transfers exists because of macro shocks - that is a fact that can be empirically verified - unless you believe Germany will never experience severe negative economic shocks its just matter of time. Given what we know about macroeconomics shocks are unavoidable regardless of policy $\endgroup$ – 1muflon1 Jan 31 at 14:44
  • $\begingroup$ @dm63 Regarding c) I fully agree with you but question was whether euro collapse is inevitable not likely or possible - in the first line of my answer I stated collapse of euro is possible. In fact it is possible even in the best times since its in the hands of EU politicians and politicians might have motives that go well beyond economics (e.g. getting votes from nationalists or see exhibit 1 Brexit which from economic perspective is disaster for UK economy but from political perspective it was likely optimal gamble for Cameron). $\endgroup$ – 1muflon1 Jan 31 at 14:46

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