Can monetary union survive in Europe without some form of fiscal union or other closer integration of the region’s government finances?

Increasingly, as borrowing costs in Spain and Italy soar towards and past the 6% mark and as Greece’s newly-elected leaders have promptly begun to demand an easing of the terms and conditions associated with that country’s bailout package, a school of thought is taking shape that if monetary union is to survive the crisis at all, it may do so only because of some form of closer integration. Certainly, the current approach simply isn’t sustainable; as Spanish Prime Minister Mariano Rajoy cautioned earlier this week, “we can’t keep funding ourselves for a long time at the prices we’re currently funding ourselves”. In other words, having to pay 7% interest on newly-issued bonds simply isn’t a sustainable plan.

The problem? So far, at least one of the parties whose agreement would be required to measures that would see all eurozone members share some liability for the group’s total debt has refused, point-blank – and in most cases that holdout has been German Chancellor Angela Merkel. With a two-day European Union summit set to kick off tomorrow evening, Merkel told German parliamentarians in Berlin that proposals aimed at finding a way to pool the region’s sovereign debt load that are premature. “I fear that at the summit we will talk too much about all these ideas for joint liability and too little about improved controls and structural measures,” she said. “Joint liability can only happen when sufficient controls are in place.” (Privately, Merkel is reported to have been far more dogmatic in her opposition to such steps, saying she doesn’t expect to see them happen in her lifetime.)

But as this Reuters Breakingviews analysis argues, all that may be needed to salvage the situation is an interest subsidy that would cost eurozone members about 50 billion euros over the next seven years. It’s a more modest form of fiscal union – the core eurozone countries like Germany wouldn’t need to provide an overt guarantee of the debt of countries on the periphery, such as Spain. But it also would recognize that when they linked their monetary policies together more than a decade ago, eurozone members also de facto acknowledged that their fortunes will rise and fall together.

The proposal analyzed in this Breakingviews article is the brainchild of two academics, Ivo Arnold, program director of the Erasmus School of Economics in Rotterdam and Pablo Diaz de Rabago, economics professor at the IE Business School in Madrid. In essence, the idea is to create a pool that would cross-subsidze eurozone debt, with the goal of equalizing borrowing rates. In Germany, currently, these are artificially low, while they have skyrocketed in Spain, reflecting the former’s role as a safe haven and market fears that the latter’s economy is collapsing. As the Breakingviews calculator below shows, this could be accomplished with about 50 billion euros over a five-year period, paid out as subsidies to help offset the higher borrowing costs in periphery nations. The result, the argument goes, would be that while German borrowing costs would rise to more normal levels, those on the periphery would fall, or at least the burden of those costs would be offset by the subsidies.

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It’s hard to imagine Germany accepting anything other than the austerity and reform packages on which it has insisted – but if anything stands a chance of winning some support from Angela Merkel, it is likely to be a suggestion of this kind. It doesn’t require major changes to EU treaties, threaten national constitutions or even run afoul of Merkel’s requirements that periphery countries forge ahead with reforms. (As Breakingviews argues, a country that fails to keep up its end of the bargain can be booted out of the cross-subsidization pool with ease, whereas they can’t be booted out of the eurozone.)

The mathematics that make this kind of proposal potentially viable, and that underlie other further-reaching proposals for some kind of fiscal union among eurozone members, is simple: when taken as a whole, as shown in the chart below, eurozone sovereign debt is actually lower than that of the United States, and in line with that of the United Kingdom. In other words, if the eurozone was actually “The United States of Europe”, the sovereign debt crisis wouldn’t be nearly as acute as it has become today.

Political objections and major constitutional hurdles may well block a move toward creating a United States of Europe. But that still leaves the door open to creative solutions that try to find ways to reach the same end using different strategies and policies. Perhaps the 50 billion euro interest subsidy may prove to be one of these.