Rebooting Europe

Debate Moderator(s):  Richard Baldwin

The Eurozone crisis emerged five years ago and is a long way from finished. Growth is miserable and unemployment – especially among the young – is unconscientiously high and expected to stay that way for years.
As a first step to finding a consensus on how to fix the Eurozone, a couple of dozen world-renowned economists were asked a simple question: “What caused the Eurozone Crisis?” Although they hark from a wide range of perspectives, a remarkably consistent answer emerges.
• Excessive, cross-border foreign lending and borrowing among EZ members in the pre-crisis years – much of which ended up in non-trade sectors – was why Greece’s deficit deceit in 2009 could trigger such a massive crisis.
At its core, this as a classic ‘sudden stop’ crisis – not a public debt crisis. Some of the intra-EZ lending and borrowing in the 2000s went to private borrowers (especially in Ireland and Spain) and some to public borrowers (especially in Greece and Portugal). When trust evaporated in 2010 and 2011, most of it ended up in government hands. As EZ governments cannot devalue or force their central bank to finance public debt, euro members who relied heavily on foreign lending had to be bailed out.
The ultimate causes of the EZ crisis were thus:
• Policy failures that allowed the imbalances to get so large;
• Lack of institutions to absorb shocks at the EZ level; and
• Crisis mismanagement.

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Lead Commentaries

Charles Wyplosz , 07 September 2015

What have we learned from the Eurozone crisis? This column argues that, very much unfortunately, we haven’t learned that much. In desperate need of a way out of the current impasse, economists and policymakers are imagining a menu of solutions. A grand panacea seems implausible, at present. So the way to proceed should follow the time-honoured European method – ‘functionalism’. The EU and the ECB must focus on modest tasks, dealing with them one by one, if we are to find our way out of the current mess.

Philip Lane , 07 September 2015

In the lead up to the global financial crisis, there was a substantial credit boom in advanced economies. In the Eurozone, cross-border flows played an especially important role in the boom-bust cycle. This column examines how the common currency and linkages between member states contributed to the Eurozone crisis. A very strong relationship between pre-crisis levels of external imbalances and macroeconomic performance since 2008 is observed. The findings point to the importance of delinking banks and sovereigns, and the need for macro-financial policies that manage the risks associated with excessive international debt flows.

Lars Feld, Christoph Schmidt, Isabel Schnabel, Volker Wieland , 07 September 2015

The Eurozone is weak. This column presents an analysis of its two prime weaknesses – the lack of economic and fiscal policy discipline leading to the build-up of huge public and private debt levels and a loss of competitiveness, and the lack of credible mechanisms for crisis response that would reign in moral hazard problems and establish market discipline. Completing the currency union’s architecture and achieving credibility for its rules are key, given the heterogeneity and rigidity of its member countries' economies.

Giancarlo Corsetti , 07 September 2015

At the birth of the euro, the fiscal, financial, and monetary institutions in Europe were not sufficiently developed. This chapter describes these inefficiencies and the role they played in the Eurozone crisis. Instability in the Eurozone grew out of a disruptive deadlock between national governments forced to address and correct fundamental weaknesses in their national economies on their own, and the EZ-level policymaking. The future of the Eurozone therefore rests on developing an institutional framework that can credibly deliver stability at the EZ level.

Paul De Grauwe , 07 September 2015

Economists were early critics of the design of the Eurozone, though many of their warnings went unheeded. This column discusses some fundamental design flaws, and how they have contributed to recent crises. National booms and busts lead to large external imbalances, and without individual lenders of last resort – national central banks – these cycles lead some members to experience liquidity crises that degenerated into solvency crises. One credible solution to these design failures is the formation of a political union, however member states are unlikely to find this appealing.

Stefano Micossi , 07 September 2015

The sovereign debt and banking crises of 2010-12 have led to significant changes in the institutions of the Eurozone. The credibility of common policies regarding budgetary discipline and economic convergence remains weak. This chapter proposes that the way forward is to gradually bring common economic policies under the oversight of the European Parliament and to strengthen the role of the Commission. The picture must be completed with getting national parliaments more involved in the European policy process. The present state of the Eurozone could be seen as a sort of political equilibrium, likely to be economically unstable.

Beatrice Weder di Mauro , 07 September 2015

Inadequately dealing with high public debt is the central cause of the continuing crisis. This column argues that, while other failures of the institutional framework have been recognised and partly dealt with, the failure to deal with the legacy excess debt may continue to haunt us for decades. Even worse, the failure to complement fiscal rules with an effective sovereign restructuring regime may be setting us up to repeat the same mistakes.

Jeffrey Frankel , 07 September 2015

No-one is optimistic about the Eurozone’s prospects. This column highlights the major causes of the Eurozone crisis, highlighting that many US economists thought the euro a bad idea from the outset. Previous emerging market crises have important lessons for Europe – if Alexis Tsipras were able to shift gears in the way that Kim dae Jung did in Korea and Lula did in Brazil, he would better serve his country.

Elias Papaioannou , 07 September 2015

The focus of European policymaking in the 1990s was on meeting a set of nominal criteria. This chapter argues that instead the focus should be on institutional reform and convergence. The main issues that need to be addressed are related to state capacity (tax collection), property rights protection, investor rights, red tape, and administrative-bureaucratic quality. If Europe is to proceed with an even closer union, it should set up institutional rather than nominal targets.

Thorsten Beck, José-Luis Peydró , 07 September 2015

The past five years have given European countries useful insights on what works in crisis resolution. The lessons should be viewed as forward-looking contributions to the institutional and policy reform agenda in Europe, especially in the Eurozone. The Eurozone is not doomed, it just needs better economic and financial policies.

Guido Tabellini , 07 September 2015

What are the main lessons to be drawn from the European financial crisis? This column argues that the Eurozone really is at a major cross-roads. Without a common fiscal policy, and without adequate institutions for aggregate demand management, European leaders have to constantly alter the rules. Currency risk will be the major concern of financial markets, much more than in the past, due to how Europe has dealt with the Greek crisis.

Daniel Gros , 07 September 2015

The Eurozone crisis started as a sudden stop to cross-border capital inflows. This chapter suggests that countries with current-account surpluses did not endure lasting financial stress. The balance of payments crisis then became a public debt crisis, where the public debt which mattered was that owed to foreigners. Overall, the crisis proved much more difficult to deal with given the predominance of bank financing, thinly capitalised banks, the absence of a common mechanism to deal with failing banks, and the absence of a common lender of last resort.

Paolo Pesenti , 07 September 2015

Proposed remedies for the Eurozone crisis abound. But proven, working solutions are hard to come by, especially when traditional solutions – structural adjustment and monetary policy – are seen as causing problems. This column concentrates on the policy recipes prescribed on both supply-side and demand-side to jump-start economic recovery and reduce the extent and spillovers of the crisis itself. It finds that there is no easy and straightforward strategy and that there are no obvious answers. That doesn’t mean, however, that there are absolutely no answers. The alternative option to finding a way out – that is, continuing reliance on deflationary adjustment in a currency union stuck at the zero lower bound – is probably unlikely to convince anyone that structural reforms and monetary policy are back to being part of the solution.

Agnès Bénassy-Quéré , 07 September 2015

The problems in the Eurozone are not a side effect of the Global Crisis but rather date back to the Maastricht treaty. This chapter proposes a few possible remedies. First, it is necessary to make debt restructuring possible within the Eurozone. In particular, the risk loop between sovereigns and banks needs to be stopped through more diversified balance sheets. The second suggestion involves more shared sovereignty, not only for debtor countries, but also for creditors. At a minimum, the Eurozone needs a fiscal backstop for its banking union.