Germany's Concern Is Moral Hazard, Not Morality

The principal assertion made by professor Krugman concerning the German response to the euro area crisis is that it is all about "morality and debt is evil". That, however, is a mischaracterization of the underlying reasons for the German unwillingness to immediately sanction large bailouts and focus on harsh austerity measures in the euro area. The real issue is moral hazard, not morality, and is rooted in the design flaws of the common currency, which grants member states (or at least did until the crisis) full sovereignty over issues such as their banking sector and most fiscal policy.

There is no doubt that in the ideal world the best response to a financial crisis is to deploy the "Powell Doctrine" of deploying overwhelming public sector financial force to quickly restore confidence among private investors. Such bailout actions, however, are inevitably politically premised on full ability of the "bailout giver" to dictate the actions of the "bailout recipient." There was no political problem in, for instance, the United States, when Congress passed the TARP (Troubled Asset Relief Program), as Congress is fully sovereign and can dictate the actions of U.S. recipients. Similarly with the standard modus operandi of the IMF (International Monetary Fund), which only grants bailouts to governments that sign on to tough economic reform programs beforehand and essentially lose their national sovereignty in process.