Europe's New Plan: Procyclical Fiscal Policy plus Hope by Yglesias
Meanwhile there are rumors that the IMF and Italy are making a deal.In terms of Europe's actual economic problems, however, this idea will make things worse not better. The big problem with the Eurozone is that the underlying economy simply isn't that integrated. The Portugese economy is very different from the Dutch economy, and Portugese workers face a lot of hurdles in relocating to the Netherlands or Finland where suddenly they'd be inconveniently illiterate in the local language. That means it's objectively difficult for the European Central Bank to set monetary conditions that are equally appropriate for all countries. During the credit boom, the ECB pursued policies that were too loose for southern Europe's economies. Then during the contraction, it's pursued policies that are too tight for southern Europe. It's not possible to target all the countries appropriately. The proposed continent-wide fiscal straightjacket will exacerbate the problem. If Eurozone-wide conditions warrant monetary policy that pushes Finland into recession, the new rules will mandate that Finland undertake sharp tax hikes and spending cuts that further deepen the recession. Thanks to balanced budget rules, American states already operate this way and it's a pretty serious problem. The good news for America is that we have a federal government with the ability to smooth out some of the pro-cyclical impacts of state and local budget. Europe has no such thing.
UPDATE: Henry Farrell's excellent review essay on the problematic evolution of European institutions (PDF) is very relevant here. Once again when faced with a political problem, the EU's lack of legitimacy is forcing it to reach for a "techical" solution that will further undermine its legitimacy.