The eurozone is still stuck in a sluggish and uneven recovery, six years after the onset of the financial crisis. The countries with heavy sovereign debts are finding it difficult to address the overhang, since rising tax revenues from resumed economic growth have not materialised. Several countries will struggle to keep their deficits on a downward path. As long as they continue to run deficits their debt burdens continue to rise.
There are two developments which would help: a resumption of steady economic growth, of which there is limited evidence, would cut deficits without further austerity, and inflation at a modest level. A little inflation helps to reduce the real burden of debt and makes it easier to manage costs downwards. Unfortunately the average eurozone inflation rate has fallen to just 0.5 per cent per annum, versus the official target of 2 per cent.
To make things worse, the inflation rate is lowest in the heavily indebted countries, zero in some. The full nightmare scenario is zero growth and zero inflation: the adjustment problem for heavily indebted countries becomes impossible and they could default on sovereign debt, as Greece has already done.
Official policy at European level is that budget deficits must continue to reduce. The Government is expected to extract a further €2bn or so in October's Budget. This will further deflate domestic demand in an economy already experiencing high unemployment. The same picture applies in other over-indebted countries.
Meanwhile, the level of bank credit extended to the private sector in eurozone countries continues to contract and the exchange rate of the euro remains strong, one of the reasons for the low inflation figures. The only element in overall policy which is in any way appropriate for the weaker countries is the key ECB interest rate, already down to 0.25 per cent.
Conscious that there are no shots left in this particular locker, the ECB, at its meeting on Thursday, intensified its strategy of hinting at possible measures to loosen monetary policy in due course, but no actual measures were taken.
In the United States and in the UK, the monetary authorities have, with some success, engaged for several years now in a policy called 'quantitative easing', or QE, which involves injecting liquidity into the system through direct purchases of financial assets. Their economies have recovered rather better than the sluggish eurozone.
The ECB has declined thus far to copy the US and UK initiative, but further hints were dropped on Thursday that QE is an option.
The eurozone is a peculiar construction and the ECB is a peculiar central bank. The macroeconomic policy in force is to do too little, and to do it too late.
Resistance, from Germany in particular, has not prevented the ECB from responding to the deflationary impulses unleashed by the crash but it has weakened and delayed the measures actually taken. Progress towards a banking union has been painfully slow and there is no guarantee that the eurozone will be re-engineered as a proper monetary union.
Without banking union and some prospect of escape from the sovereign debt problems, the eurozone is continually exposed to renewed crisis.
Countries in trouble have virtually no independent policy levers. They cannot devalue, since they have abolished their currencies and are stuck with whatever external value the euro reaches in the market. They must cut their deficits to regain or retain bond market access and to comply with EU rules.
They cannot create liquidity domestically, lacking central banking autonomy. Thus economies already weak are trapped in a deflationary policy environment, and it is little wonder that economic commentators should be searching around for escape hatches. In his book released on Wednesday last Cormac Lucey argues that Ireland should quit the eurozone by re-establishing an independent currency and should also default on its sovereign debt*. These are distinct policies - Greece defaulted without leaving the eurozone while it is conceivable that a country could leave a common currency area without defaulting.
Lucey proposes that Ireland do both, as a package. He argues that the decision to abolish the Irish currency in 1999 was a mistake. While it should be recalled that quite a few commentators opposed the move at the time it is not clear that a financial bust would have been entirely avoided through staying out of the eurozone. Several non-euro countries got into serious trouble too. The combination of plentiful international funding through poorly-managed banks was not confined to the eurozone.
In Ireland, the warnings about the credit and public spending bubbles, and there were plenty, found no traction with the authorities, which elevated complacency to the status of a policy doctrine. It is likely that the excessive capital inflows which fuelled the bank lending bubble would have been less readily available to a country whose currency was at risk of devaluation.
On this view euro membership made the bubble larger than it might otherwise have been, and made it harder to deal with when it burst, but the failings of domestic bankers and policymakers would have created a sizeable bubble anyway. The euro decision cannot be ascribed sole, or even the principal, responsibility for current woes. There were also domestic policy blunders after the bubble burst, particularly the blanket bank guarantee of September 2008.
Superimposed were some blunders at European level, notably the arbitrary Exchequer costs imposed on Ireland, and only Ireland, by the actions of the ECB under the presidency of Mario Draghi's predecessor Jean-Claude Trichet. Purchasers of unsecured bonds issued by bust banks were repaid in full at the expense of taxpayers and other government creditors, adding to the sovereign debt crisis.
After six years of painful adjustment in Ireland it is deeply frustrating to have to face the reality that the task of restoring economic normality is far from complete, and that policy options are so circumscribed in the euro straitjacket.
Lucey's Plan B is born of this frustration. The sovereign debt stands at over 150 per cent of GNP and government is still running a sizeable deficit. Debt of the household sector is almost 200 per cent of personal disposable income.
The banks remain fragile and some may still be under-capitalised. The road to a restoration of financial stability in Ireland will be long and difficult and must be navigated in the hostile environment of a poorly designed common currency area.
The common currency area is moreover resistant to reform and unsympathetic to the plight of countries trapped in a system whose policy stance seems geared to the interests of its dominant members.
Conceding that it was a mistake to join the euro in the first place, does it follow that the right option now is to find an exit? This possibility was explored in detail in the case of Greece and the alternative of sovereign default was chosen instead. There are good reasons for this choice. It is wrong to imagine that exit from a common currency area can be engineered as readily as the currency devaluations which were a feature of the predecessor fixed exchange rate system.
The eurozone countries do not have national currencies anymore, having abolished them in 1999. In order to devalue on exit, a country would have to establish a new currency from scratch, persuade people to hold it, and then devalue. Aside from the intimidating logistics, there is a risk of massive outflows prior to the implementation of the change and more generally that people would simply decline to adopt the new currency on any substantial scale.
There is no gain, even temporarily, from introducing a soon-to-be-devalued currency that nobody uses. There is also the roadblock that the European treaties contain no mechanism for euro exit, and any unilateral move could result in suspension of membership in the EU itself.
The second and distinct proposal in Lucey's book is default on the sovereign debt. This is feasible within the eurozone as the Greek example demonstrates but fraught with difficulties, including the fact that most Irish debt is now owed to official lenders, including the IMF, EU institutions and individual European countries, including the UK, which lent to Ireland during the crisis.
It would be a better option to explore first the possibilities for further measures to ease the debt burden, in particular the unreasonable debts imposed by the ECB under Trichet.
Cormac Lucey, 'Plan B – How Leaving the Euro Can Save Ireland', is published by Gill and Macmillan.