“The Eurozone has no mechanism to defend itself against a drawn-out depression”
In the Eurozone the European Central Bank (ECB) has played the role of insurer for the currency in the “euro-crisis”. That crisis came from the bond market where different speculators invest in the failure of some states member of the Eurozone. Today, the threat comes not from the markets, but from the extremist political parties that want to leave the Eurozone. Such parties saw their consensus increasing a lot in the last few years, due to a shift in the “median voter” position in the political arena. This shift is caused by the worsened economic condition in different countries. Hence, the “median voter” who became in general poorer, is more inclined to support radical parties’ opinion. The probability of suffering a loss for a voter is conditional to the economic situation in the home country. Therefore, such as in an insurance, it is very difficult to estimate this probability with accurate precision. However, the main point in this parallelism between the insurance theory and the Eurozone is that voters could not trust any more in the insurer, i.e. the ECB. If these radical parties take the power, several important countries will leave the Eurozone.
In order to avoid the chaos and a damage deriving from a loss in credibility, the ECB has prevent the failure of any member states, since the failure of a member state could represent an insurance contract in which the insurer company fails. From this point of view, a member state of the Eurozone is insured, being part of the monetary area. Of course, several objections could be raised from this statement. First of all, there is a problem of moral hazard. The sovereign government could take “riskier” fiscal policies since another supranational authority, ECB, bails out in any cases. To solve this issue, it is created an insurance contract such as the insured pays a price and he/she could participate partially to the risk, in the forms of deductibles. The deductibles are defined as the amount of money that the insured has to pay out of pocket for expenses before the insurance company will cover the remaining costs. With this mechanism of risk sharing, it is possible to control and limit the moral hazard behaviour.
In our monetary context, the sovereign states take part in the capital of the ECB in shares that reflect the GDP relative to the entire Eurozone (e.g. the Germany is the major “stakeholder” and it has almost 18% versus 14% for France, 12.3% for Italy and so) . These shares can be seen as the price paid by each states to be part of euro system. If the ECB suffers some losses, all states will recapitalize ECB with respect to the relative shares. Therefore, the governments have to be careful in the policies implementation, otherwise they will spend some resources to recapitalize the ECB’s capital. This structure is similar to risk sharing in the insurance framework. In fact, every countries participates to the ECB’s capital and their policy choices today have an impact on their responsibilities in the future. In conclusion, thanks to an “insurance mechanism with risk sharing”, it is possible to have the insurance’s benefit and avoid the moral hazard problem.