Lorenzo Bini Smaghi of ECB in another superb speech criticises people/media attacking Euro.
He begins looking at why public finances have worsened in this crisis. It is because as global economies slumped and uncertainty rose, government was the only way to restore normality. In this process, public finances took a hit. Fin markets started noticing this but have focused exclusively on Euro area where as it has lower debt levels compared to others. Well, this is not fully true as De Grauwe pointed household and private sector debt are very high.
Anyways, he points to one interesting point. People are attacking ECB as it would not allow inflation tax. Inflation tax means central bank allows inflation to rise and this lower government debt. Smaghi says this is actually a virtue as then countries will be pushed to cut down their deficit levels. If there is inflation tax we are merely postponing the problems.
They have focused on the euro area, even though it has on average a lower deficit and a lower debt ratio than other economies. There are two reasons for this. They have to do with the particular institutional construction of the euro area, which is built on two pillars.
One is the monetary pillar, which is supported by an independent central bank with a clear price stability objective. This implies that the ECB will not use an inflation tax to reduce the real value of government debt. Euro area governments have thus to rely on budgetary measures to address their own fiscal problems. These measures are difficult to adopt, especially in countries with fragile political systems, such as those with minority governments or weak leadership, or where growth is projected to be slow due in particular to lost competitiveness or heavy reliance on external borrowing. Financial markets are testing each country, one by one, to see whether they are willing to adopt the necessary budgetary measures, starting with those which seem to be facing the greatest hurdles to consolidation.
Let me digress briefly on this point. Some may think that the fact that the ECB cannot use the inflation tax to bail out Governments is a weakness of the euro area’s construction, because it obliges some countries to make fiscal adjustments earlier than others. In my view, this is a strength. To believe that an inflation tax can solve the problem posed by the mounting public debt is an illusion that some people like to cultivate. For several reasons. First, people are less naïve than some might think – they dislike an inflation tax as much as other forms of fiscal adjustment. Second, it’s not so easy to generate inflation, in particular ‘surprise’ inflation, without provoking a more-than-proportional increase in interest rates, also in light of the short average maturity of public debt in most countries. Third, a rise in inflation, and inflation expectations, would produce a major upward shift in the yield curve, inflicting major losses on the banks and financial institutions which have been heavily investing in these markets, potentially undermining the recovery.
He says Euro area was based on four principles:
The second pillar of the euro area construction concerns the economic and fiscal dimension. It was based on four key assumptions. The first was that markets would exert strong pressure on euro area fiscal policies. The second assumption was that if the first assumption were insufficient to discipline public finances, then the Stability and Growth Pact, based on monitoring, peer pressure and sanctions, would do the job. The third assumption, reinforcing the previous ones, is that if a member of the euro area were unable to implement sound fiscal policies, it would be left to its own devices. The final assumption was that national economic policies would be geared to ensure convergence among euro area economies, within a strengthened single market.
All these four were found wanting and has been covered extensively now. He says we need to work on all these four constructs.
He adds people are just making statements without any detailed analysis.
Read the whole thing. This along with this previous speech pretty much sums up what European policymakers feel about this ongoing crisis.
Mostly Economics 
