The Eurozone crisis: Too few lessons learned

Charles Wyplosz

07 September 2015



The Eurozone crisis started in early 2010. Five years later, growth is miserable and is forecasted to remain miserable (European Commission 2015). Governance is in disarray as the tragic summit of 13 July showed.

Political considerations have trumped economic analysis, maybe because we economists have been unable to come up with a collective view. More likely, politicians have reluctantly been led to micromanage complex technical issues as the result of an amazing accumulation of economic mistakes, which they are unwilling to recognise (Wyplosz 2014).

The debate on the economic causes of the crisis will continue to be perfectly confusing. Authors typically focus on their pet explanations, using a slew of carefully selected data, within partial equilibrium analyses that allow them to ignore the elementary distinction between endogenous and exogenous variables. For example, what can we conclude from studies that consider as exogenous the current account, capital flows or inflation differentials? In any vaguely general equilibrium setup, these are endogenous variables.

On the other hand, some policy failures can be identified and treated as exogenous to some degree.1 In some crisis countries, fiscal indiscipline can hardly be dismissed as the exogenous trigger. In others, a sharp reduction of interest rates led to unchecked credit growth and to housing bubbles. This suggests faulty banking supervision. Poor bank resolution and the absence of a lender of last resort translated banking crises into debt crises. These policy failures must be part of any explanation.

One aspect that is less studied is the mismanagement of the crisis. How has it been possible that political leaders did not benefit from professional advice? Why have they accepted discussing, meeting after meeting, the technicalities that are normally dealt with at the level of Sherpas, Sous-Sherpas and the like? What happened to the European Commission, which employs a large number of competent economists? Why has the IMF, the world expert on economic and financial crises, been at best side-lined and at worst become willing to compromise its intellectual reputation?

Lessons from the crisis

The simple answer to these questions is that the European treaties never anticipated that there could be such a crisis. This is normal, after all. Crises are crises because they are not foreseen. Still, there have been voices warning of treaty imperfections that could lead to banking crises (Begg et al. 1998). Similarly, there was no lack of early warnings that the Stability and Growth Pact would not be able to deliver fiscal discipline, a necessary condition within a monetary union. Moreover, the debate on the community vs. the intergovernmental method, which is as old as the Treaty of Rome, has never been resolved, leaving the EU in a vacuum that would prove lethal in the event of a crisis.

To make matters worse, we believed in the fairy tale that the ECB is ‘the most independent central bank in the world’ because its statutes say so and cannot be changed realistically. Yet, it has been painfully obvious that the ECB has been behind the curve throughout the crisis. Its inability to emulate world-class central banks reminds us of the Bank of Japan throughout this country’s two lost decades, which was then under the domination of the Ministry of Finance. Truth is that the ECB has been mesmerised by diverging public opinions.

The Five President Report intends to frame the policy responses. Unfortunately, it is an unimaginative catalogue of pious statements that call for ‘more Europe’, without any analytical justification. Of course, a fiscal union or a political union, for whatever these vague terms may mean, would be wonderful and might even deal with some of the problems – if they were well done.

  • Everyone knows, however, that no further transfers of sovereignty are now possible.

A much deeper Europe is simply not thinkable at a time when the rising political forces are the Front National in France, the Five Star Movement in Italy, Podemos in Spain, True Finns in Finland, the Party for Freedom in the Netherlands and, until recently, the Alternative in Germany.

  • Arguing for a fiscal union or a political union is the intellectually lazy response.

The challenge for Europe is not to mimic the USA, which is beyond reach for a generation or two, but to find institutional answers that are as original as the Single Currency.


Only one of these severe institutional failures has been dealt with, but only partly. The Banking Union still lacks a single resolution authority, an unwieldy ‘mechanism’ is not enough. It does not have a lender of last resort. The European Stability Mechanism offers conditional and limited support that is not up to a systemic banking crisis and the €50 billion resolution fund-to-be only serves as a reminder that the US Troubled Asset Relief Program mobilised $400 billion, most of which was spent in bank recapitalisation.

The biggest prize so far is the Single Supervision Mechanism, which has remained silent on the situation of the Greek banks, widely seen as bankrupt. Its only action has been to announce stress tests in September. Real supervisors act in a matter of hours.

Fiscal discipline

Establishing a proper fiscal discipline framework remains an unfulfilled vital necessity. The policy response has been more of the same, just worse.

  • The Stability and Growth Pact is in permanent contradiction with budgetary sovereignty.

Making it ‘stronger’ only sharpens the contradiction. Burying attempts to undermine national sovereignty in extensive bureaucratic exercises (the European Semester, the Excessive Deficit Procedure and the Macroeconomic Imbalance Procedure) is unlikely to work.

  • There is no alternative to scrupulous respect for the no-bailout clause, which has been repeatedly undermined since 2010.

Replacing intrusive ex ante conditions with a clear ex ante rule stands to set incentives straight. Fiscally undisciplined governments and their lenders must know with 100% certainty that they will not be bailed out. This should be a no-brainer; the real challenge is working out how to restore the clause.

Central banking

The ECB has had to face asymmetric shocks, the scourge of monetary unions when the common monetary policy is bound to be seriously sub-optimal in most countries. On top of conflicts of interest, the crisis has also brought to the surface deep disagreements on economic principles and policy responses that had been muted during the easy years of the Great Moderation.

  • Generally accepted macroeconomic principles have collided with the Hayekian and ‘ordoliberal’ ideas prevalent in Germany.

These disagreements have percolated to the Eurosystem’s Governing Council, leading to long delays in dealing with the crisis.

In principle, vigorous intellectual debates are healthy but they can be crippling if they boil down to unresolved disagreements intertwined with conflict of interests. Policymaking institutions cannot function effectively in such conditions. Internal debates must remain confidential and give way to wholehearted support for decisions once they are made. A central bank can only be independent if it earns the support of the public opinion. When there are different public opinions that follow national lines, this becomes mission impossible.

It may be reassuring to remember that the US faced a similar situation during its first century and even during the early years of existence of the Fed. Somehow, the influence of strongly held national views will have to be limited. Since it is unlikely that the treaties can be changed, the ECB must be given the means to recover effectiveness.

One specific issue can be dealt with within the treaties. As it interacts with banks on the money market, the ECB accepts as collateral, and sometimes purchases a large menu of assets, including public debt instruments. This has served it well during the financial crisis but it has had deleterious effects once the sovereign debt crisis set in.

A logical way out for non-crisis times is for the ECB to only deal with assets that are truly European. Eurobonds or the ECB own debt paper could become the only accepted instrument, thus removing the vexing problem of potential losses attached to national bonds.

Crisis management

Finally, effective crisis management conflates all the ambiguities of European governance. The Community Method was lost when governments rightly considered that there were deep fiscal implications. The intergovernmental method was crippled for two reasons. First, not all EU members have adopted the euro so some governments had to be excluded. Second, 18 governments cannot manage a crisis. For a variety of reasons, the largest country exercised leadership. Even if the decisions thus taken were correct, this is plainly not acceptable.

Unfortunately, the solution will be very difficult to imagine. Unsurprisingly, the response of the Five Presidents is to look for some ‘European government’ with real powers, including a budget and taxing power alongside a Eurozone parliament. As argued above, this solution is most unlikely to be politically possible. The German Finance Minister has suggested reducing the role of the Commission, thus further eroding the Community method. However, this means politicising crisis management, a sure recipe for ineffectiveness and divisiveness.


Some solutions are reasonably easy to envision, others will require a huge research effort and the even bigger ability of politicians to challenge their own conventional wisdom. If a grand solution is impossible, the way to proceed is likely to follow the time-honoured European method called ‘functionalism’. This means focusing modestly on tasks and making it possible to deal with them one by one. The ECB is in charge of monetary policy and financial stability. Fiscal discipline requires a new framework. The banking union must be completed. Crisis management remains a black hole.


Begg, D, P de Grauwe, F Giavazzi, H Uhlig and C Wyplosz (1998), “The ECB: Safe at Any Speed?”, Monitoring the European Central Bank 1, CEPR, November.

Wyplosz, C (2014), “The Eurozone Crisis: A Near-Perfect Case of Mismanagement”, Economia Marche Journal of Applied Economics 33(1): 2-13.

European Commission (2015). European Economic Forecast, European Economy 2, European Commission, Economic and Financial Affairs, Spring.


1 A large literature seeks to endogenise policies. This literature is important and most helpful, especially when it links failures to institutions. This is the spirit of this essay.



Topics:  EU institutions EU policies Europe's nations and regions

Tags:  ECB

Professor of International Economics, Graduate Institute, Geneva; Director, International Centre for Money and Banking Studies; CEPR Research Fellow