The Tragedy of the Euro Is the Incentive to Incur Higher Deficits and Make the Whole Euro Group Burden the Costs of Irresponsible Policies

The tragedy of the Euro is the incentive to incur higher deficits, issue government bonds, and make the whole Euro group burden the costs of irresponsible policies—in the form of the lower purchasing power of the Euro. With such incentives, politicians tend to run high deficits. Why pay for higher expenditures by raising unpopular taxes? Why not just issue bonds that will be purchased by the creation of new money, even if it ultimately increases prices in the whole of the EMU [European Monetary Union]? Why not externalize the costs of government spending?

The resulting moral hazard is asymmetrical. Governments of larger states would produce considerable inflationary pressure running high deficits and might be too big to be bailed out. On the contrary, governments of smaller states would not produce much inflationary pressures even if they would run high deficits because the impact of the money creation would not be important for the Eurozone as a whole. Moreover, small countries could expect to be bailed out by larger countries. It is unsurprising that the sovereign debt crisis has been worse in small countries such as Greece, Ireland and Portugal.

The tragedy of the Euro is aggravated by the typical shortsightedness of rulers in democracies: politicians tend to focus on the next election rather than the long-term effects of their policies. They use public spending and extend favors to voting factions in order to win the next election. Increasing deficits delays problems into the future and also into the other countries of the Eurozone. EMU leaders know how to externalize the costs of government spending in two dimensions: geographically and temporarily. Geographically, some of the costs are borne in the form of higher prices by the whole Eurozone. Temporarily, the problems resulting from higher deficits are possibly borne by other politicians and only in the remote future. The sovereign debt problems caused by the deficits may require spending cuts imposed by the EMU.

—Philipp Bagus, The Tragedy of the Euro, 2nd ed. (Auburn, AL: Ludwig von Mises Institute, 2012), 107-108.