Europe: After the crisis

Europe has moved forward in fits and starts, ever since it began coming together in the 1950s. Currently it is having a fit. It is hard to see quite how and when this will end, but we doubt if this crisis will end either swiftly or well.

Europe, or rather the Eurozone within it, could easily come to appear in tatters, at least temporarily. But the European ideal has so much power that crisis and even division will not permanently prevail. There have been several prior serious set-backs:

• The break-up of the snake in the tunnel; and
• The collapse of the Exchange Rate Mechanism; and

Each time the leaders of Europe absorbed what were thought to be the prior lessons and bounced back to drive the European project forward yet again:

• The collapse of the snake in the tunnel led to the ERM; and
• The collapse of the ERM led to the single currency.

Perhaps Eurozone leaders will once again react in this way.

A political crisis as well

The current crisis has been far more than just an economic crisis; it has been a political crisis also. This has been so for two reasons.

• First, and at a more superficial level, the crisis has been handled primarily by the political leaders of the major nations, notably German Chancellor Merkel and French President Sarkozy, supported by the current and previous Director-Generals of the IMF, both of whom happened to be French.

The leaders of the EU as a whole, President of the Council Herman van Rompuy and President of the Commission Jose Barroso, had no money, little legitimacy (having been the place-men of the national leaders), and scant power. These two played, at best, a walk-on supporting role.

The national political leaders each were subject to national political interests and constraints, which they had to balance against diverging views of the longer term future of the Eurozone. While all agreed to the end of saving the single currency, there was no agreement on the means. As a result, the political discussions often resembled a cacophony, with eventual, last minute compromise on the minimum necessary to hold the Eurozone together for the time-being; with the time-being measured in months, not years. Politics, if anything, has prolonged and worsened the crisis.

• Second, and at the deeper level, this sorry tale has been a symptom of the failure of the elite to engage the mass public in the European project.

This project has been driven forward by the elite. Apart, perhaps, from the population of Brussels, the primary allegiance of most of the public remains to their nation state, (or to their local region, eg Catalonia or Scotland). As a result national leaders are almost solely constrained by perceived national interests, and there is no counterbalance from Europe-wide political leaders, since the latter have no democratic legitimacy and no money.

The lack of legitimacy was built into the working of the EU by having the President of the European Commission and the President of the Council of Ministers appointed by the cabal of national political leaders. Insofar as there is an executive of the Eurozone, eg in the guise of the President of the European Commission, we, the people, have no more role in that appointment than in the case of an hereditary king or an elected Pope. We do vote for Members of the European Parliament (MEPs). But the main role of a legislature is to hold the executive to account, and to constrain its freedom of action by limiting taxation, the power of the purse, ‘no taxation without representation’.

Europe as a democratic polity

If Europe is to become a democratic polity, this has to change.

• The first proposal here is about reformulating the basis for appointing the President of the European Commission and the other Commissioners; the President should be elected by EU citizens and then allowed to appoint Commissioners.

Annex 1 (at end of column) consider various aspects of this proposal in more detail.

Meanwhile money and power are intimately related. As has been exemplified in the recent crisis, it is problematical to try to issue money without the power to support that via taxation. Equally without access to money (notably via taxes), the power to undertake countercyclical, or cross-country, stabilisation is limited.

• The second proposal is to assess what fiscal changes might be needed to accompany a single currency – essentially revisiting the exercise done on this some twenty years ago (Commission 1993a).

This latter exercise was turned down flat by the richer, Northern countries at that time (1993), partly because they saw it, (not entirely correctly), as a ‘transfer union’.

It is likely that the proposals advanced here will similarly be found to be ‘ahead of their time’. So the question then becomes whether, and how, in the absence of more appropriate, and deeper, political and economic reforms, a single European currency could be made to function more effectively. The answer is that there is a set of such possible improvements, largely building on an overdue appreciation that the Maastricht criteria for joining the monetary union and their current implementation for members – the Stability and Growth Pact – were badly designed. Better designs can be found, implemented, and made self-reinforcing.

Taxation

One of the key levers of power, and the main support for any currency, is the power to tax. With the EU being a different kind of political construct from the normal federal country, the power for the European executive needs to be greater than at present, but still tightly constrained. What such powers should be was considered at some length in Commission (1993a).1 There is no need to reinvent the wheel. The report, Commission (1993a), remains the most comprehensive study of the complementary fiscal path that the Eurozone should have taken together with monetary union. EU leaders conspicuously failed to follow its advance, with results that are now all too obvious. Since this study was done some two decades ago, it will have skipped most memories.

The fiscal counterpart to a monetary union

The main points are summarised here; see Annex 2 (at end of column) for more detail and reasoning.

• First, a small budget of about 2% of EU GDP is capable of sustaining economic and monetary union, including the discharge of the Community's growing external responsibilities.

Shock absorbing features within national fiscal systems (eg among US states) are based on much larger expenditures but this is because the main expenditures serve other purposes – shock absorption is a welcome but unintended side effect.

For a stabilisa­tion instrument to be pure and effective, three principles are key (see Goodhart and Smith 1993 for details):

• The instrument should be triggered following changes in economic activity but its intervention should be halted as soon as no further changes occur, irrespective of the level at which the economy has again become stable.

Otherwise, the instrument would perform not only a stabilisation function, but also play a redistribu­tive role. Such an 'impurity' is typical for traditional fiscal policy measures, but should be avoided in the Community context as it may perpetuate adjustment problems and induce transfer dependency.

• The instrument should make its impact during the de­cline in real economic activity, and not afterwards, when the economy has stabilized or is already recovering.

If the intervention affects the economy too late, undesir­able fluctuations around trend growth will be amplified by government action. As stressed in Friedman (1953), timing is critical to the success of stabilisation policy, as well as hard to get right because downturns can be sharp yet relatively short-lived and any discretionary instrument is subject to the problem of recognition and policy implementation lags which can easily amount to more than half a year.

• Given the need for speed, the activation of the instrument should therefore be prefer­ably linked to an indicator, whose fluctuations form a close proxy for variations in real output, and whose measurement is accurate and quick.

Stabilisation is usually seen as arising through the effect of public financial transfers on private agents' incomes, and hence consumption.

• The stabilisation instrument should make a significant contribution on the margin to the income of individuals in the affected Member States.

On top of these requirements, the Eurozone instrument should reflect three additional considerations. The instrument should:

• Only provide support inasmuch as the registered economic decline displays a clear country-specific dimension, rather than EZ wide shocks.

Shocks affecting the whole monetary union should be responded to by fiscal policy coordination, national automatic stabilizers, and ECB monetary policy, if price stability permits.

• Only act as insurance against grave economic difficult­ies, ie only in the event of major negative developments.

In keeping with the reasoning that the stabilisation instrument compensates for the loss of the exchange-rate instrument, and recognising that devaluation is not resorted to for every dip in economic activity, the instrument should act as an insurance against grave economic difficulties.

• Take the form of grants, not loans.

Loans would not be appealing to EZ members with strong international credit rating who can smooth shocks with their own borrowing. Nor would they be useful to members with already high debt-to-GDP ratios as they would raise the country's level of indebtedness, pushing it further into the 'excessive deficit' zone. In essence, loans might undermine the credibility of the stabilisation goal.

Politics and new fiscal rules and enforcement

In 1993, attempts to construct a minimalist federal fiscal reinforcement for a monetary union were rejected rapidly and comprehensively by the rich Northern nations. The likelihood of moving towards some fiscal counterpart to monetary union today remains slim. But would it be politically possible?

Such a proposal would obviously only relate to the Eurozone countries, and not to the ‘out’ countries (thus avoiding a UK veto). To reassure doubters that this is not the first step on a slippery slope to a ‘transfer union’ with all its ‘moral hazard’, rules of behaviour would be necessary. The need for such rules is clear.

The absence of any central fiscal authority to support the single monetary union led to the creation of the Maastricht criteria and Stability Pact. These criteria were badly designed, not only focussing unduly on public sector deficits, rather than on current account deficits, but also having an incredible, and in the event unusable, set of sanctions. Let us start with the first shortcoming, which stemmed from a number of implicit, and incorrect, assumptions.

• The first, and most important, incorrect assumption was that a private-sector deficit in any country, matched by a capital inflow (current account deficit), should not be potentially destabilising.

The thinking was that the private sector must have worked out how to repay its debts before incurring them.

• The second misguided assumption was that, in a single monetary system, local current account conditions not only cannot be calculated, but do not matter.
• The third was that the public sector deficit of a member country is just as damaging when it is matched by a national private sector surplus, as by capital inflows.

Public-sector debt can be redeemed in one of three ways: i) by a revenue surplus of tax over expenditures; ii) by inflating it away, or iii) by defaulting on it. Eurozone members forego the second option, so redemption requires a budget surplus or default. As taxes falls only on citizens, while default also affects foreigners, the nationality of creditors matters. If all debt is domestically held, the choice between tax and default converge; the choice is primarily a domestic matter. There will be indirect effects on other members of the monetary union, but so long as the domestic authorities choose the outcome with the greatest social welfare to their own citizens, that same choice will generally also be to the benefit of other members of the monetary union, (yes, one could construct artificial counter-examples, but are they realistically likely?). In short, public debt and deficit rules must take account of the extent to which the debt is foreign-held, and how far such deficits are matched by continuing capital inflows.

Destabilising private debt linked to non-traded goods

This analysis also applies to certain types of private debt and deficits, namely external debt incurred for the provision of non-tradeable goods (housing, etc.). In such cases the debt can only be paid off – ie the current account deficit replaced by a surplus – if the economy shifts production to tradeable from non-tradeables.

Exchange-rate devaluations are the usual way of engineering such shifts – especially after a ‘sudden stop’ to capital inflows. But such devaluation is ruled out by a monetary union. Hence debts, and deficits, incurred as a counterpart to rising household debt levels, and non-tradeable construction, are just as potentially destabilising to a monetary union as public sector deficits.

This parallel between private external borrowing for non-tradeables and public debt was simply not recognized before the current crisis struck, especially not so in the cases of Ireland and Spain who had enjoyed a public sector surplus in the run-up to the crisis.

New stability rules

This analysis implies that the Eurozone needs a wholesale reorientation of the stability conditions. They must be refocused towards concern with external debt, and deficit, conditions and much less single-minded focus on the public sector finances.

If a member country is in a Japanese condition with a huge public-sector debt, but fully financed domestically, with a current-account surplus and large net external assets, then its debt should entirely be its own concern, and not subject to censure or control by any outside body, whether in a monetary union, or not. Of course, such greater attention to external, especially current-account, conditions needs to be more nuanced, since deficits, and external debts, incurred to finance tradeable goods production subsequently should provide the extra goods to sell to pay off such debts.

Enforcement

Belatedly the European Commission has been moving in this direction with its new Excessive Imbalances Procedure, (see details in Annex 2). The Excessive Imbalances Procedure should, one would hope, replace the old Maastricht criteria as the basis for Eurozone corrective policies. How might it work?

The European Commission plans in this area will have two key elements: (i) 'a pre­ventive arm' that focuses on the early warning of macro­economic imbalances, and (ii) 'a corrective arm' that takes effect when harmful imbalances appear.

According to Buti and Larch (2010), the preventive arm’s first trigger is an alert that identifies potentially problemat­ic macroeconomic imbalances (see Buti 2011 for details). This leads to 'in-depth' study that determines whether an imbalance is problematic or benign. If this step concludes that the imbalances are exces­sive, ie are severe or jeopardise the monetary union, the 'corrective arm' is activated. The EZ member concerned will be subject to an 'Excessive Im­balance Procedure' involving stepped-up surveil­lance centred on a remedial action plan put forward by the member in response to more prescriptive country-spe­cific policy recommendations issued by the Council. Repeated failure to comply will lead to year­ly financial sanctions determined by the Council using a reverse qualified-majority voting procedure.2

The ‘analytical, preventive’ arm is quite well designed, but, once again, the ‘corrective’ arm, involving enforcement and sanctions, is not.

The suggested sanction still takes the shape of a financial penalty to be imposed on the wayward government, albeit now quasi-automatically. There are several major objections to this.

• If the financial penalty is small, it would not have much effect.
• If large, it would worsen public-sector finances, just when these are likely to be weak.
• Such pecuniary fines are likely to inflame anti-European political sentiment in the country at the receiving end.

For example, would it make sense under current circumstances to fine Greece and Portugal for running a current-account deficit? Again for a sovereign country, the standard response to a persistent current-account deficit is devaluation. When a country voluntarily gives up its ability so to do as a member of a monetary union, is it appropriate for that same monetary union to fine a member country facing current-account problems?

Using credit downgrades as punishment for stability transgressions

A much more suitable sanction would be an enforced credit-rating downgrade, whenever external debt/current-account deficit was matched by a combination of public-sector and household debt/deficit. Certainly the details and numerical thresholds would be complicated, but it would relate the sanction (a worsening credit rating) directly to the problem, ie the likelihood of default with cross-border spillover, externalities. The aim would be to downgrade the credit ratings of countries getting into unsustainable external positions well before this threatened the financial stability of both creditor and debtor countries in the Eurozone.

A valid criticism of the credit-ratings agencies has been that, under political pressure, they have downgraded the ratings of (important) sovereign countries far too late in the course of the current crisis; that relates as much to the US as to the Eurozone. In view of the fact that the EC has been so focussed on public-sector debt/deficit, it has been both weak-kneed and short-sighted of them to play along with the self-interested complaints of national governments that such downgrades were premature and unjustified, whereas in reality the reverse has been the case.

What this implies is that sanctions, in the guise of credit downgrades, have to be embedded in rules agreed ex ante. Leaving it to the discretion of the authorities ex post to act as judges in their own case is to guarantee the failure of such a system. The rules could be based on a ‘comply or explain’ procedure, perhaps giving the Commission the capacity to explain why the downgrade rule should not be applied in some special circumstance (which explanation should also be agreed by the European Parliament).

The frequently advanced proposal to develop a European ratings agency is generally ridiculed as a self-serving mechanism for maintaining artificially high ratings. The only European ratings agency that would have any real value would be one that was required by transparent ex ante rules to be manifestly tougher and more rigorous than the present lot of the for-profit credit-rating agencies. That would be a good idea. Might it happen? Perhaps when the present EZ crisis has been analysed in more depth, the case for it may become better understood, but again the chances are slim.

Banks and governments

The Eurozone crisis has been much complicated by the interaction between national governments and their domestic banks.

• In federal unions, sub-sovereign member states can, and do occasionally, go bankrupt without devastating results.

This is largely because their failure does not automatically entail the collapse of their own financial system, since the latter has become dominated by federally diversified financial intermediaries.

• A Eurozone country cannot default, except to a strictly limited degree, without bringing down its own banks, and insurance companies. (And vice versa, the main banks of such a country cannot default without bringing down the finances of the public sector of that country.)

A country can go on operating, more or less, if public sector expenditures have to be reined back to such levels as current receipts allow. But a country cannot function if its banks and payment system close. Ultimately foreign banks might take over, but the lags involved would seem to those affected like an eternity.

The most pressing and immediate threat to the maintenance of the euro has always been a bank run, or bank failure, that the rest of the Eurozone (the ECB) cannot, or will not, check; under such circumstances a national government has little alternative but to leave the monetary union, and to save its own banking system by resort to a reconstructed printing press (plus exchange controls).

This problem would be ameliorated if the main banks in the member states were all very large cross-border euro-banks, so that they were so diversified that the default of a (small) member state would not cause their own subsequent failure. But this would not be likely when a larger member state was at risk, or one with a particularly large debt. Moreover it causes another problem. Larger cross-border banks are likely to be large relative to the size at the fiscal authority in their own headquarter country. Their cross-border activities may be too large to save for their home country; and no good way to handle the burden of the failure of a cross-border bank amongst the countries involved has yet been found (Gros and Micossi 2008).

Coping with potential banking crises

So much of the problem of preventing public sector crises from breaking up the monetary union transmutes into the related question of how to cope with potential banking crises. There are three ways (at least) with coping with the burdens/losses of bank crises. These are not mutually exclusive.

• The first is to try to prevent them by requiring much higher equity ratios, reinforced (and this is necessary) by credible intervention in the guise of temporary public ownership whenever such equity capital should fall anywhere near a danger area, (as measured by market, as well as by accounting, values).

The draw-back of this is that bank management, upset by falling Returns on Equity results and declines in equity prices, might respond by deleveraging and seeking ever more keenly to find loopholes in regulation to manipulate in order to maintain returns. One answer to this transitional problem would be to restrict dividends, and perhaps increases in executive compensation, until not only were the capital ratios achieved but also the starting level of bank assets were re-attained.

While this could most easily be done by increasing holdings of government debt, rather than lending to small and medium enterprises, such a course would not be very profitable, especially during periods of deflation and low official interest rates, and would raise interest rate risk. Moreover, such intervention would be widely perceived as draconian and inconsistent with a capitalist system.

• The second is to place the burden on creditors, by requiring banks to issue so-called Co-Co bonds, and to make the bonds issued by both banks and governments subject to bail-in, whereby the bank/government remains in operation but the loss gets absorbed by the bond holder in reverse order of seniority.

If bank/government failures/crises were random, or idiosyncratic, events, this would be the way to go. Unfortunately the serious crises are systemic in character. The likelihood of a bail-in (Co-Co) trigger getting pulled in one instance is likely to close the primary market for new bail-in-able issues for any other bank/country with even a remote chance of meeting the same fate. Faced with such an inability to raise such new bond finance, banks would be forced to sell assets, thereby worsening the downward spiral (Goodhart 2010).

Because most analysts think only in terms of the effects on the individual bank/country, the proposals for Co-Co/bail-ins are getting much more support than they deserve as an antidote to systemic problems. Rather than worry about the effects of the first bank/country to face default, proponents of Co-Co/bail-ins need to address the question of how these arrangements would affect the prospects of all the others in difficulties at the same time. When one tries to design a system proof against failure, contagion should be the main concern.

• The third approach is to have some kind of insurance fund to meet the loss burden and to prevent forced closure of systemically important banks.

The next question is who meets the cost? There is no good way to assess the premia that each bank should pay ex ante, though it could be related to equity ratios. If the latter, one reverts to the problem of bank management’s focus on return on equity. There is also a concern about moral hazard, though this should be prevented by employing a combination of both risk-weighted and simple leverage capital asset ratios.

If the insurance cost is to be met ex post by the surviving banks, it runs into several problems. First, the tax, being ex post, has no beneficial effect in encouraging more prudent bank behaviour ex ante. Second it imposes a greater burden on surviving banks just when they are most fragile and need profits most desperately to rebuild their strength. The cynical might conclude that such support as the industry gives to ex post, over ex ante, bank taxes is partly due to the expectation that the manifold disadvantages of such an ex post tax would cause its imposition to be deferred or lightened in the event.

That, of course, leaves the taxpayer as bearing the brunt of any such bailout. We have seen the political and economic limitations of that route. The current cry is for a massive increase in some European fund, a major extension to the European Financial Stability Fund. But this is, in effect, and so perceived to be, a contingent claim on the German taxpayer, and as such is not likely to be accepted.

Perhaps a more realistic proposal, which harks back to the suggestions would be to build up, ex ante, an insurance fund, financed for example from seignorage from euro note-issue. This fund would need to be mainly invested (when not required) in non-Eurozone assets so that sales (ie to buy equity in euro-banks in difficulties) would strengthen euro values. Such a fund would have the characteristics of a Eurozone sovereign wealth fund. One can argue that it is not just oil-rich countries which need a sovereign wealth fund as a protection against systemic future crises.

Conclusions

Four points follow from the analysis:

• There is a need to revisit the political and economic underpinning of the Eurozone.

A monetary union does need some minimal centralisation of powers to work. We need to review what such minima may be. A look back at the exercise the Commission published in the early 1990s, “Stable Money – Sound Finances”, would be a good starting point.

• The new Excessive Imbalances Procedure correctly shifts the focus from public-sector deficits/debts towards external deficits/debts; but the enforcement/sanctions component is misguided.
• The problem with the ratings agencies has been that they have downgraded sovereign ratings far too late, not too early.

A mechanism is needed to rectify this, and the Excessive Imbalances Procedure could be the right vehicle.

• The most severe Eurozone problems have arisen from the interaction between bank and public-sector debt.

There is no really good way to resolve this. Enthusiasm for bail-ins of bond holders is overdone. Bank taxes have numerous disadvantages. There is a case for building up a sizeable Eurozone sovereign wealth fund for use in emergencies.

References

Buti, Marco (2011) ‘Balancing imbalances: Improving economic governance in the EU after the crisis ’in ‘Europe in crisis ’in CESIFO Forum Summer 2011 pp 3-11.

Buti, Marco and Martin Larch (2010). “The Commission proposals for stronger EU economic governance: A comprehensive response to the lessons of the Great Recession”. VoxEU.org, 14 October

Commission (1993a). “Stable Money – Sound Finances: Community public finance in the perspective of EMU”, European Economy, No. 53.

Commission (1993b). "The Economics of Community Public Finance ", European Economy: Reports and Studies No. 5, December.

Goodhart, Charles A.E. (2010). “Are CoCos from Cloud Cuckoo-Land?”. VoxEU.org, 10 June.

Gros, Daniel and Stefano Micossi (2008). “Mother of all bailouts and what it means for Europe”, 20 September.

Annex 1. Politics: Elect the Commission President

The single most important political reform for the EU is to have the President of the European Commission elected by the voters, not appointed by the Council of Ministers. If she is to be elected, there needs to be a democratic contest, and, to understand what the candidate represents, each candidate should publish a manifesto of intended policies.

How would a candidate for President emerge? One way would be to allow any Prime Minister, or set of Prime Ministers, representing more than, say, 75 million people to put a name in contention. Arrangements could be made to ensure that there were always at least two candidates, and for selecting a winner when there were more than two candidates, and none got over 50% of the votes.

In order to retain a proper EU balance, the same number of Commissioners would be appointed from each country as now. But the successful candidate for President would choose her own slate of such Commissioners. It would be expected that candidates, prior to election, would give an indication of whom they might have in mind for the more important of such positions. The Commissioners would, of course, support the policies set out in the manifesto. The period in office of the Commissioners would be coterminous with that of the President, perhaps five years with no renewal. Continuity would be provided by the Commission staff.

European Parliament elections

Elections to the European Parliament would be, intentionally, on a different cycle, say once every three years, so that, if the European voters were unhappy with the executive direction of the EC, they could elect a Parliament that would rein it back.

The purpose of the exercise is to construct a European polity, and power centre, that answers directly to the people of Europe, and is not simply an apparatus managed by national political leaders.

Annex 2

The Commission economist Marco Buti (2011, pp 5/6) writes:

“In the decade preceding the crisis, macroeconomic imbalances in the EU and within the Eurozone increased considerably (European Commission 2010a). The warning signs were that current accounts of some member states increased to staggering deficits while for others current account surpluses built up. External imbalances can be problematic but not necessarily worrisome if deficits/surpluses arc natural responses to changes in underlying fundamen­tals and the related saving and investment decisions of households or businesses. For instance, countries in the catching up phases often run current account deficits by investing in building up the stock of pro­ductive capacity. This, in turn, increases the prospects of future income and ensures their ability to repay the borrowed capital. Similarly, countries with ageing population may find it opportune to save today, ie run current account surpluses, to avoid a drop in con­sumption in the future (Obstfeld and Rogoff 1996).

However, high and persistent current account imbal­ances pose a policy challenge and need to be tackled if they are driven by market failures or inappropriate policy interventions. In this respect, external imbal­ances might reflect other types of imbalances such as excessive credit expansions or asset bubbles. In these cases, the capital imported is not invested in produc­tive activities that would enable the future repayment of today's incurred liabilities. Current account posi­tions can also be a sign of an imbalance if they reflect weaknesses in domestic demand.

Indeed, the growing imbalances in the EU and partic­ularly in the Eurozone reflected, at least in part, unsus­tainable macroeconomic developments. Some mem­ber states saw their price and cost competitiveness improve markedly, while others significantly lost com­petitiveness. Price and cost competitiveness indica­tors, such as Real Effective Exchange Rates, clearly document the increasing divergences in the EU and Eurozone. In addition, some Eurozone countries have shown a worrying gradual deteriora­tion in export market shares.

The growing external imbalances were reflected in a buildup of domestic imbalances such as excessive credit growth in the private sector, housing imbal­ances as well as structural weaknesses of domestic demand and the inappropriate adjustments of wages to a slowdown in productivity. In particular, countries such as Greece, Spain or Ireland experienced rather fast rates of growth which were to an important degree driven by domestic demand booms and expan­sions in non-tradeable sectors, notably, albeit not exclusively, construction.

As a result of this process, fuelled by low financing costs and increase in cross-border capital flow, resources were often channelled into unproductive uses. Figure 4 shows that the excessive credit expan­sions stimulated demand and pushed current account into deep deficits in some member states. Similarly, housing prices grew fast in many EU countries, in sev­eral cases developing into housing bubbles. Con­versely, domestic demand in other member states appears to have been constrained, in part, due to existing rigidities in product markets. This, together with mispricing of risk in financial markets, resulted in increasing current account surpluses.”