engleski

“Moral hazard” as a threat to real convergence in the European Union

The principal motive behind the whole process of Economic and Monetary Union is the idea of a faster real convergence of the living standards of the member countries, i.e. faster growth rates and augmenting productivity. But the real convergence is not a required criterion. The real convergence is a residual of the process of nominal convergence. In the Economic and Monetary Union, in an environment of “impossible trinity” where free capital movements are guaranteed, where currency union is a mid term obligation of every accession country and the monetary sovereignty is being seceded to the European Central Bank, the nominal convergence criteria from Maastricht promoting sustainable debts and deficits are supposed to be a guarantee of stability. Political internal and external “moral-hazard” of using the fiscal and monetary policies to promote short-term political goals has long-term consequences on central and eastern European countries wishing to join the European Union. It is a game theoretical problem as the governments incurring the deficits are not the same governments having to repay the debts. It is a situation of “moral-hazard” that left alone could lead to a vicious circle of an adverse selection of candidate countries for the Economic and Monetary Union: a “league of lemons”. The Maastricht debt and deficit criteria have been proven unsuccessful in curbing the external political “moral-hazard” because of the free- riding of some large countries in the past, especially Germany and France. The external “moral-hazard” is the consequence of the internal one. The problem may be exacerbated by the federal structure of some countries where there are no internal debt and deficit requirements, and potentially leading to systemic proportions. Smaller countries are probably not going to endanger the monetary union, but it is rather a matter of principle. There are two tiers of countries: too big to fail countries and too small to endanger countries. In this way one of the equilibrium could be a total break-up of the EMU. The “good” countries are unable to exclude the “bad” countries: a typical problem of “adverse selection”. What are the possible equilibrium of this game-theoretical problem, and what is the best behavior of a country joining the EU and subsequently the EMU?

EMU, economic convergence, moral-hazard, game theory

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