In
recent weeks, debt markets have undergone wild gyrations, leading some
analysts and commentators to question the progress achieved in taming
the sovereign debt crisis in the eurozone.
More recently, economic data and forward-looking indicators have
emerged that many economists think point to a faltering of the global
recovery, compounding the general anxiety.

Instead of focusing minds, however, these developments have prompted a
cacophony of prescriptions about what western governments should do
next. There have been calls on regulators to rein in speculators, on the
central banks to loosen monetary policy further, on the US and Germany
to use their supposed “fiscal space” to encourage demand and on European
Union leaders to take an immediate leap into a fiscal union and joint
liability. Now more than ever is a time for clear messages and clear
priorities.


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Whatever
role the markets may have played in catalysing the sovereign debt
crisis in the eurozone, it is an undisputable fact that excessive state
spending has led to unsustainable levels of debt
and deficits that now threaten our economic welfare. Piling on more
debt now will stunt rather than stimulate growth in the long run.
Governments in and beyond the eurozone need not just to commit to fiscal
consolidation and improved competitiveness – they need to start
delivering on these now.

The recipe is as simple as it is hard to implement in practice:
western democracies and other countries faced with high levels of debt
and deficits need to cut expenditures, increase revenues and remove the
structural hindrances in their economies, however politically painful.
Some progress has already been achieved in this respect, but more needs
to be done. Only this course of action can lead to sustainable growth as
opposed to short-term volatile bursts or long-term economic decline.


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There
is some concern that fiscal consolidation, a smaller public sector and
more flexible labour markets could undermine demand in these countries
in the short term. I am not convinced that this is a foregone
conclusion, but even if it were, there is a trade-off between short-term
pain and long-term gain. An increase in consumer and investor confidence and a shortening of unemployment lines will in the medium term cancel out any short-term dip in consumption.

These efforts will inevitably bear fruit, but it will not come
overnight. This time, we will have to take the longer view. For too long
we have forsaken long-term gains for short-term gratification with the
result we all know.

The members of the eurozone have and will continue to collectively
provide conditional financial assistance to those countries that find
themselves cut off from capital markets, buying them time to put their
public finances on a sustainable footing and to improve their
competitiveness. There are risks to this strategy. Yet the alternative,
by allowing the crisis to infect the eurozone as a whole and threaten
the euro, would be riskier still.

When markets become the bearer of bad news, there is a natural
tendency to take aim at the messenger. The truth is that governments
need the disciplining forces of markets. But markets, like the human
beings they are made of, do not always act rationally. In uncertain
times and absent a robust regulatory framework, their volatility can
exacerbate a crisis.

There is a broad consensus now that more robust, crisis-resistant
markets need strong regulation. But the process is laborious and
momentum in the Group of 20 appears to be fading. In this context, it
may become necessary for key countries to move ahead unilaterally in
specific areas. Last year Germany introduced a limited yet controversial
ban on naked short-selling.
Today I would see the introduction of a financial transaction tax in
Europe as another case for such a “pacemaker-approach” by a few,
important pioneers.

One central lesson of the financial crisis was that markets could
only function properly if risk-taking were not divorced from liability.
The loosening of this bond was a central factor of the crisis. Likewise,
the eurozone crisis unfolded after a decade during which economies with
markedly different and, indeed, diverging fiscal profiles and
competitiveness were all able to borrow at close to benchmark rates.

Hence my unease when some politicians and economists call on the eurozone to take a sudden leap into fiscal union
and joint liability. Not only would such a step fail to durably solve
the crisis by addressing only its most superficial symptoms, but it
could make it worse in the medium term by removing a key incentive for
the weaker members to forge ahead with much-needed reforms. It would
also go against the very nature of European integration.

Europe has always moved forward one step at a time and it should
continue to do so. This does not mean that fiscal policy in the eurozone
should not gradually become more centralised. It should, as long as
this process is legitimised by a strong democratic mandate. But
strengthening the architecture of the eurozone will need time. It may
need profound treaty changes, which will not happen overnight. But the
direction is not disputed, and the determination of all member states to
defend the common European currency is granted.