No Exit, No Default: So What? The Controversies of Economic Governance in the EU

The well-known impossible trinity of international economics claims that countries are unable to initiate full capital mobility, a fixed exchange rate regime and an autonomous monetary policy all at the same time. One of these goals should be necessarily sacrificed in order to meet the other two. By launching the EMU project, countries of the European Union decided to fix their national currencies irrevocably and maintain full capital mobility in exchange for the delegation of their monetary policy onto a supranational level. The most recent sovereign debt crisis of the EU, however, has dramatically challenged the sustainability of the whole euro-zone. Until very recently, the EU has strongly insisted on the following three conditions: no country can leave the monetary union, no bail out is allowed in the case of financial difficulties and absolutely no default is allowed. All three “no’s” have been indispensible pillars of the European economic governance structure.

The crisis, nevertheless, has mercilessly demonstrated that these three pillars are not compatible with each other in the event of a financial distress. By now it should be clear for all member states that one of these “no’s” should be given up in order to tolerate the other two. Accordingly, this constraint is called as “the impossible trinity of denial”. The paper demonstrates that only by a drastic redesign of the governance structure of the euro-zone can countries re-establish the viability of the whole European integration process.

Journal of Economic Literature (JEL) codes: E62, H50, H60

 Keywords: economic governance, impossible trinity, euro-zone, bail-out, sovereign default,