Trichet Says Eurozone Will Need a “Finance Ministry” (6/9)     Print Email

In a valedictory speech before leaving the European Central Bank in October at the end of his eight-year term, Jean-Claude Trichet called for the creation – eventually – of a central finance ministry for the eurozone with powers to intervene in the budgetary and economic decisions of member states.

The idea startled many observers as a politically controversial proposal liable to raise hackles about sovereignty. It was attacked as smacking of “desperation” by critics such as the conservative British academic Niall Ferguson of Harvard. But widely respected economist Simon Johnson of MIT praised the Trichet statement in a Bloomberg article, saying that it was not intended to be a panacea for the current debt crisis. Instead, Trichet was suggesting that greater institutional oversight and intervention will be necessary to prevent another economic meltdown in the eurozone.

In his speech, accepting the prestigious Charlemagne award for service to Europe, Trichet said that help must continue to flow to debt-laden states in the eurozone in order to protect the future of the euro as a feature of the EU. He said that the eurozone remains strong despite the current pressures on it. In the medium term, however, the currency union will need a central financial ministry with the authority to regulate fiscal policy in individual member states.

Trichet’s argument turns on the vexed issue of getting the political legitimacy in the EU to impose tough economic management. In his speech, he noted that interdependence must work both ways. Close economic ties among the countries using the euro meant that prudent participants now are being asked to pay for the badly-managed economies. Shouldn’t these more stable countries be able to intervene to correct fiscal folly in other states before it becomes too late?

Acknowledging the economic sense of Trichet’s suggestion, Johnson argues that obtaining political legitimacy will be the problem with this plan to override national economic sovereignty. Since the euro’s creation under the Maastrich Treaty in 1992, Johnson says, Europe has lived with an uneasy compromise. Due to the lack of a political appetite for a fully-empowered central fiscal authority, European leaders opted for a weaker ECB with powers largely confined to setting interest rates. That system allowed banks across the EU to buy up debt issued by EU governments that was in effect risk free – operating with very high rates of leverage compared to their capital reserves and thus fueling the situation that has wreaked havoc on European banks’ balance sheets. Hence, Johnson argues, Trichet’s proposal would finally get the political horse in place with the economic cart. Further, such a eurozone “finance ministry” could issue debt and represent the eurozone in international finance institutions. Johnson calls this idea “just as brilliant as Alexander Hamilton’s fiscal and financial integration proposals for the young American Republic.”

The full text of Trichet's speech is available here.