 He holds the John Paulson Chair in the European political economy at the London School of Economics, has a number of other hats as well, and his book which I'm very much looking forward to reading and has got great reviews, it looks at the perennially topical issue of the balance between the state and markets in modern economies. When things didn't look as good as they look today, this was in the midst of the sovereign debt crisis. In fact, I think it was 2012, I don't remember the exact date anyway, but the mood seems to have improved a little in Ireland, can I say so? So I'm very pleased to be back, and I'm going to talk about the future of the Euro, right? And let me immediately start. So what I want to do is the following. I will first discuss what I call the design failures in the Eurozone. What are they exactly? And that will take about half of my time, I think, and then I will be more prospective and ask the question of the future, which implies how to redesign the Eurozone so that it can become something that is sustainable in the long run, because one of the problems we have, I guess one of the great difficulties with the Euro is that we have created a money, a currency, without creating a country, right? And the question that arises is that sustainable? Or another way to put it, can we make it sustainable? What does it mean to make it sustainable? Do we have to create a country to make the Euro sustainable? What does that mean, then, creating a country? So these are all the issues that will come back while I'm discussing this. So let me, first in a nutshell, talk about these design failures, and then I will go into each of them in somewhat more detail. And first of all, I would like to say a few things about dynamics of booms and busts in capitalism, right? Capitalism is a wonderful system. I think, and I mean it, I mean, it's a mechanism that has been at the source of welfare creation in the world, and it's based on liberty and enterprise in people, so it's a great system, but it's also very unstable. It creates booms and busts, right? And they have been there with us for hundreds of years, right? And they will continue to be there for the rest as long as we maintain capitalism, right? And that has created a number of problems. The first one that I identify here is that while we have booms and busts, and I will show you some pictures about this, it almost automatically creates divergence in movements in competitiveness, right? Some countries boom more than others, and then creating divergence in competitiveness that will have to be corrected afterwards, and that's usually very painful. So that's probably the best known part of the problem that we have in a monetary union. It has been analyzed in great detail in what is called the theory of optimal currency areas, where a lot of emphasis is put on asymmetric shocks, but here I would like to think more in terms of endogenous movements, right? These booms and busts and creating divergences that I will illustrate further on. So that's one. The second problem that I will insist a lot on is that while capitalism was evolving, nation states have created a number of stabilizers to reduce the hardship for people when the downturn comes, right? And these stabilizers were organized at a national level. And when we stepped into the monetary union, these nation states lost, in fact, their capacity to stabilize, to deal with this problem of how to stabilize the economy. And nothing was created at the level of the Eurozone to compensate for that loss at a national level. And that, of course, creates a very deep problem because these nation states that are expected by many people to do something to make the world more comfortable for its citizens that these nation states cannot provide anymore, right? They are naked and fragile, unable to deal with these disturbances. And all this done, and I don't have to tell you this in this country, was these movements were reinforced by the deadly embrace of sovereign embankments, and it was one country where this has been at the core of the crisis, then it's probably Ireland. So I will not deal very much about this issue here and concentrate more on one and two. Okay, let me turn to the first point, booms and busts. One of the surprising things when, and I'm going to show you this picture immediately, is that the business cycle within the Eurozone has been highly correlated. Here what I show is the business cycle component of GDP. It's basically the output gap, right? So it's the difference between output and some long-term trends movement. And so I show that here on the vertical axis. And on the horizontal axis, you see the time if it starts in 1995 until 2014, right? And the first striking thing is that there was so much correlation. So you had a period of booming conditions, right, until here, about 2007, and then very strong downward movement, right? So very high correlation of the business cycle. We were, the Eurozone was gripped by a similar movement, first of booming condition, optimism, and then a decline, pessimism. Da symmetry is in the amplitude of this cycle, right? This is Ireland, and this one is Greece, right? And this is Ireland. So Ireland, Greece were those countries with the highest amplitude, right? Huge boom, and then a, I almost said great crash, no terrible crash, right? A terrible crash, right? While in other countries, the amplitude was much less. In Germany, for example, it was very weak, right? So if there is a symmetry, it's in the difference in amplitude. And that creates a number of problems. In fact, one we'll have to do with competitiveness. It leads to large divergences in competitive position. And second, it also leads to instability in government bond markets during the downswing. So that's what I want to distill from that little empirical analysis. So let me first turn to divergences in competitive positions. Here, because the amplitude was so different, and some countries experienced a very strong boom, which means much stronger inflationary pressures, much stronger increases in wages than other countries that also experienced a boom, but a very weak one. We saw this movement here, and that is the relative unit labor costs of what I call the detonations, the countries that have become detonations at the end of the road, right? And here's Ireland, right? It's very pronounced. During the boom, wages and prices increased very strongly. And then when the crash came, you had to do an internal devaluation, bringing back these levels, right? And other countries had similar experiences, right? And so here we faced a situation where countries that experienced this very strong booms, then also later on when the crash came, had to introduce internal devaluations that are extremely painful. And note the following. The other countries that are much less gripped by this boom saw very little happening in their relative unit labor costs, and also after the crash, did nothing in the reverse. And as a result, the whole of the adjustment to this divergence in competitiveness had to be done by the countries that had lost competitiveness, because these guys here, right? Finland, Belgium, Netherlands, France, Austria did not want to do an internal devaluation, stimulate their economies, right? So that the task and the adjustment costs of these countries would be reduced. And so the whole burden of the adjustment was pushed into the countries that had experienced a strong boom and then later the crash. So it was an asymmetric system, which of course, this is a big problem, but there was no willingness to provide, to have a common approach in macroeconomic policies, yeah? And of course, I don't have to tell you all this, of course it's not in our economic models, right? But all this leads to political upheaval, people that are hit by these downward movements will reject it or turn to parties that promise that one can have a better life outside the human zone. And that is the situation we experience today, right? We have created a system that is not capable of generating adjustment systems that will lead to sharing of the cost of the adjustment. And as a result, in some countries, the pressure to leave that system is building up. So that's one problem, right? I started out showing you these booms and busts leading to these divergence in competitiveness and the problems we experience when we want to adjust to that. The second problem has to do with the fact that this system, because of the absence of stabilizers that existed at the national level, can easily become unstable. And let me explain and can in fact lead to self-fulfilling crisis pushing countries into bad equilibria. Let me explain where it comes from. It comes from the fact that when countries join the Monetary Union, the governments of these countries have to issue debt in a currency that is not their own currency anymore. It's like issuing debt in a foreign currency. It's like all the Eurozone countries have become Argentinas that have to issue debt in dollars, right? And that makes you very fragile. Why is that? Well, essentially because none of these governments can give a guarantee to bondholders that they will be paid out at maturity, because the governments cannot be sure it will have the liquidity to pay out to bondholders. And that contrasts with standalone countries that issue debt in their own currency take the United Kingdom. And the UK government can give an iron-clad guarantee to bondholders. Don't worry, you will always be paid out in pound sterling, right? This is a bond in pound sterling. And you will always be paid out in pound sterling. If high treasuries happen not to have the pound sterling in my cash machine here, I have the Bank of England there in the back that will provide the cash. And I can force the Bank of England to do so. None of these members of a monetary union can force the common central bank to do so. So they are alone, right? And as a result, they cannot give that guarantee. And not being able to give that guarantee then creates the potential for self-fulfilling crisis. When the markets get scripted by fear, the fear that the sovereign will be illiquid, that fear will create illiquidity, right? That's the beauty of self-fulfilling crisis. I would say intellectually it's the beauty of self-fulfilling crisis, right? Not in real life, of course. It's terrible. But the idea that all these things, you fear something, because you fear, it becomes reality, right? We often have that in economics, right? Leading to multiple equilibria and all this, right? And as in academics, we like this, right? Many equilibria. Anyway. So when is this triggered? Well, this is typically triggered when there is a recession. Because given the fact that the government budget is very much linked to the state of the economy, when you have a recession, then government revenues decline. You have to pay out unemployed and as real budget deficits increase, debt levels increase. And if you are in a system like I've shown you, where some countries have a very strong boom, and then afterwards a very strong downturn, you will have great differences in the evolution of government finances. Some of these countries suddenly that increase dramatically, leading to fear in financial markets and selling of the bonds of these governments that you think are in trouble and going to the governments that you think are safe. You generate unstable capital flows in the system away from those you don't trust, towards those you trust, right? Which then in turn forces the governments that are hit by this liquidity problem, right? Because the liquidity is withdrawn from the market at the time. Those who sell the bonds will use the liquidity they obtain to buy safe bonds. And as a result, liquidity is withdrawn from the market and the central bank gets into trouble, liquidity crunch, right? Forcing it to apply immediate austerity, right? You don't find the cash what you do, raise taxes and reduce spending. When do you do it? In a recession. So you have to eliminate the automatic stabilizers. Well, you shouldn't do it. You want to have the stabilizers working in a recession, right? But this phenomenon, this sudden stop and capital flowing from the weaker to the stronger perceived countries, right? Creates the inability of countries to use their stabilizing function, right? During a downturn. They have to in fact apply austerity when they shouldn't do it, right? And as a result, automatic stabilizers are switched off. So the absence of a lender of last resort in the sovereign bond markets eliminates another stabilizer, the automatic budget stabilizers, and can push countries into a bad equilibrium, forcing them to austerity and aggravating the problem, right? And no, the thing is that as investors notice, right, that with this fragility, they will more likely run away, right? If you're in a room and you know this could easily be set on fire, the least, just a little trigger, you all run to the exit, right? And the markets are like that. Once fear is there, it grips people and you get reactions of panic. And so that can lead to countries being pushed into bad equilibrium. And this has happened. I mean, I'm just telling now what has happened, right? And it will happen again, except if we do a number of things. I've done in the past a little case study which Paul Krugman called pain in Spain. Here it is. It's only just I want to show you two little graphs. This is the debt GDP ratio in the UK and Spain. Blue is Spain. Red is the UK. And prior to the crisis, you can see that Spain, the debt to GDP ratio was sort of a downward path, right? It was 60 at the start of the eurozone and it had dropped below 40%. And in the UK it was about this stable. And then came the crisis which had similar effects on the debt position of Spain and the UK, right? It explosion of the debt to GDP ratio in both countries. In fact, at the end here, at the end in 2012 it was even worse in the UK. So if you had asked an extraterrestrial looking at this graph and asked him who of the two countries is more likely to get involved into a default crisis, the extraterrestrial would probably say it's the UK, right? But that's not what happened. Here I show the 10 year government bond yields of the UK and Spain. So this is Spain, this is the UK, right? As a measure of the perceived default risk, right? And here you can see up to the 2010 it was more or less the same and then suddenly a refugiation, right? Which happened in Spain. Not only in Spain, quite a number of other countries in the eurozone even were more so than in Spain, but just here to compare countries with similar budgetary situations. And the market was in fact saying, no, Spain is the problem. And Spain is the problem because it can be pushed into illiquidity, right? And if you fear it will happen automatically. It could not, markets cannot push the UK government into illiquidity and default. If the UK government doesn't want to default, nobody in the world can push the UK government to default. They can do it with Spain and with Belgium and France, right? If the market is intent on hitting you, the market can push you into default, a sovereign government, right? Which is a paradox because here we are in the monetary union. We have been told that when you are together, you are stronger, right? In French I say, l'union félaforce. When you are together, you are stronger. In the eurozone, it's the other way around. When you are together, you are weaker because you are alone. There's nobody that's going to support you anymore, right? And that happened to Spain and other countries, right? And then the self-fulfilling nature of this, you fear the Spanish government could become illiquid. Let's sell the bonds. And by doing so, you make the Spanish government illiquid, right? And nobody supports the Spanish government. So that's a basic problem together with the diversity and competitiveness that we will have to face, right? So now I come to the final part, the redesign. How to redesign the eurozone, right? And we first say a few things about the tradeoff between flexibility and stabilization. You can already see what I've been saying that there are two sources of problems. The first one has to do with divergent competitiveness, whose origin is that the business cycles don't have the same amplitude, leading countries with diverging competitive positions. And you have to adjust to that. So you have to be flexible, right? To be able to adjust. And the second team is stabilization. That's the other one, right? You want to stabilize. And you need to set up institutions that make it possible that nation states can again stabilize and are not a victim of financial markets like they are. Now, today, being a monetary union has dramatically changed the power relation between financial markets and sovereigns. Sovereigns in a monetary union have become weaker relative to financial markets, except if we do something, right? Except if we do something so that sovereigns can become stronger again, right? But that is the stabilization issue, right? Then I will talk about the role of the ECB and then finally I will start dreaming budgetary and political union. So you will see me flying up there. Okay, trade-off between flexibility and stabilization. I think the response of the policymakers in Europe has been very much focused on flexibility. Let's make the system more flexible so that these losses of competitiveness can be taken care of better, right? And structural reforms have been the main idea to try to do that. So making adjustments to divergence and competitiveness smoother. So I'm not denying that these things are necessary, but my feeling is that the choice has been too much skewed towards structural reforms and not enough towards effort at stabilization, setting up institutions that allow us to stabilize this thing better, right? So that's my feeling. You may disagree on this, right? We may have a discussion on this, but that's what I, and then I will continue to go into this problem of stabilization. And here the role of the central bank is key, right? So now I'm asking the question, how can we redesign it so as to make it easier to deal with these booms and busts and the implication that has for individual nations in a monetary union? And here the common central bank is key. And in fact, the common central bank, the ECB, can mimic, take over the role of central banks in standalone countries by promising that in times of crisis, they are ready to step up into the bond market and buy government bonds, right? Like the Bank of England has been doing. Bank of England has massively bought UK government bonds, right? And so the ECB can do the same thing. Of course, there will always be a problem in the sense that in the case of the UK, is the UK government that tells the Bank of England, you will do it when I decide, right? While here we will always have to rely on the goodwill of this common central bank, because none of these national governments has the power to tell the central bank, the ECB, you will do it, right? But in any case, the ECB has understood the problem. It took a while, understood it in 2012. I think they should have understood it earlier. Then much harm could have been avoided. So in September 6th, the ECB, well, first, Draghi, you know, in London, had this famous speech, whatever it takes. And then in September 2012, the ECB announced that it will buy unlimited amount of government bonds. It's willing to buy unlimited amounts. It was called the OMT program. And the success was spectacular, right here. I show you the yields on 10-year government bonds in the Eurozone countries, and the peak was achieved in 2010 in most countries. And then after this announcement, these yields went down very, very strongly, right? Without the ECB having to do anything, it could just relax in its, in its seat. We announced it, and there it is. What happened is that the ECB, by making this announcement, took out the fear factor from the market. And then huge profit opportunities arose, right? Because with yields, the yields of the Greek bonds of, say, close to 30%, it means that the price of these bonds was extremely low. And therefore, if you now have lost the fear, you say, but here I can make a killing and buy these cheap bonds, right? That's still promised. And you can buy them, let's say, 20 cents for the Euro. That's still promised one Euro at the end of the day. So the markets then did it for you. They just bought it massively, and the yields collapsed. So it was a great success. If anything, I mean, you cannot have a greater policy success than that. You say, I'm going to do it. It works, and you don't have to do it, right? So that's really something you dream as an instrument, right? You can, you can just announce it. You don't have to do it. Of course, you have to maintain credibility that you will continue to do it, right? And that's an issue here, because we have had the second Greek crisis here, the yields of the Greek bonds increase, and ECB said, no RMT, no RMT for the Greeks, right? And that creates the issue of how if no RMT for the Greeks, maybe the other countries that in the future will not receive it. There's another problem that we may want to discuss is this is conditional, right? So it's a promise to provide unlimited amount of support conditional on an austerity program. And I think that's, that's the wrong approach anyway, but we may discuss that. So this thing is key. We need this, but it's not sufficient. We have to do more than that, right? What is the more that we have to do? And now I'm going to start dreaming, right? There's only one way, right? That is going forward towards a budgetary and political union. And when I talk about budgetary union, I will always imply that this is a political union also, right? You, if you want to transfer significant parts of the budget and budgetary decisions from nation states to the central level, then you have to do that, I mean, embedded in a democratic decision making process. So you have to, you have to create the institutions that allow you to do it in a democratic way. And so therefore, it has to be political, right? It cannot be a bureaucracy that does it for you. But what do I mean now with a budgetary union? Two dimensions. First, consolidation of a significant part of national government debts, right? Remember my analysis, if you follow me, my analysis is that we have these national government bond markets, right? That become very fragile during a recession because they are not backed up by central bank. They are backed up, but we are not 100% sure that the central bank will always be willing to do it. And as a result, that creates the potential for destabilizing flows between these bond markets, right? Internal instability that creates huge macroeconomic problems of stabilization within the systems, right? So, and therefore, it's a common sense, the way to eliminate it, and the limit is to consolidate the whole thing, that you don't have national bond markets anymore and you don't have this problem that we have in the eurozone, right? And it protects the members from being forced into default against their will by financial markets. So, you bring back the primacy of politics over financial markets, right? That's key. You have to go in that direction. We cannot continue to live in a system where financial markets dictate what politics should do. If we go on, then the system at some point will be, people will leave it. They don't want this. Nobody wants this, that financial markets dictate what politics should be, right? And so, that's the way we should go. That's the direction in which we should go. I'm still dreaming, you know? Let me go on. And the second component has to do with what is called insurance mechanism. So, you also centralize part of the budget so that you create an insurance mechanism that automatically transfers to those countries or regions that are hit badly. And so, that creates some insurance, some solidarity in the system, which is key also, right? But of course, it's very unpopular. In some countries, like Germany, it's called Transfer Union. I don't know whether there are Germans here in the room. And that's terrible. In Germany, you say Transfer Union, that ends the discussion. We don't want a Transfer Union. But if you don't want the Transfer Union, you are saying we don't want a common insurance mechanism. We don't want to help each other. It's like, yeah, you're going to marry and you tell your partner, if you're in trouble, don't count on me, right? So, this is a marriage that will not last very long. And the same is true with the Monetary Union. If you're in trouble, don't count on me, the union will not last, right? So, we need this kind of stuff. How much, of course, is something else? Well, moral hazard issues. You have to create some kinds of new problems, moral hazard risks that some of the participants may exploit this and then take on too much risk and all that. So, these are real problems that we face and that a solution has to be given to. But, of course, now I'm going back to Earth, but the Union, as I have defined here, can only be a very long run process, right? There's today no willingness to go in the direction. And therefore, only strategy of small steps can do it, right? That's the only way. And they have to be small and in the beginning, they are probably going to be irrelevant in terms of the size of the problem. But they are important in indicating the direction in which we want to go, right? And there have been a number of proposals, for example, common unemployment benefit scheme, right? You pool resources to deal with unemployment problems, but only with the cyclical component, not the structural component. And then it's an insurance mechanism that you set up at the central level, as we proposed by many people. The four presidents report some years ago, since the business angle is very much correlated, it means that such a common unemployment scheme will have deficits during a recession, handing out more payments during a recession than during a boom and therefore must be able to issue bonds, right? So, that's a first small step on the road to a budgetary union. So, that's something that can start small, and I think we should do it and that points to the direction in which we will go. I don't think the common unemployment benefits scheme as such, those that are on the table that have been discussed also, can do very much in terms of stabilization. I don't think they can. It's too small. But they point the direction in which we go, right? And I think create, I hope, a good will to go further in that direction. Some people say, yeah, the main, the objection that people have against this kind of schemes is that, well, one can do it at the national level. But my, what I've told you is that, no, you cannot do it at the national level. Because precisely when you have the business cycle downturns, given that they are so different, right, there will be sudden stops all the time, bonds sold in one market and liquidity moving into other markets, forcing liquidity crisis in some countries and liquidity, too much liquidity in other countries, like in Germany, for example. And that makes stabilization at the national level impossible, right? And it leads to all these problems that I've been analyzing. So, let me come to a conclusion. I think the long run success of the Eurozone depends on the continuing process of political unification. That's key. You cannot escape this, right? And another way to put it, the political unification is needed because the Eurozone has dramatically weakened the power and legitimacy of nation states without creating a nation at European level, right? And that is particularly true in the field of sterilization. We cannot live with this, right? People will reject such a system. But of course, I'm aware that there is integration fatigue. We will have to try to convince people, citizens, that this is the way we should go. It's going to be difficult, right? Budget a union, as I have set it out, is so far away, right? And the willingness to move in a direction at this stage is non-existent, really. I'm aware of this, right? It's not existent. And as a result, this will continue to make the Eurozone a fragile institution, and its long-term success cannot be guaranteed. Thank you for your attention.