How Inequality Fueled the Euro Crisis

The common denominator of existing eurozone-reform proposals is the completion of a banking union, which many believe is needed to reduce financial fragmentation and break the vicious circle between banks and sovereign debt. But, while this would be a positive step, it will be incomplete without efforts to reduce inequality.

BRUSSELS – Since the Great Recession of 2007-2009, most economists have begun to regard finance as a key driver of the business cycle. But the precise dynamics are not yet fully understood.

For example, the University of Chicago’s Amir Sufi and Princeton’s Atif Mian argue that credit expansion leads to nasty recessions, which emerge as soon as households, for whatever reason, lose access to the financing they need to roll over their debts. But this argument misses a key factor, exemplified by the eurozone crisis.

The creation of the euro was accompanied by large-scale financial liberalization, including the elimination of capital controls and the adaptation of the legal framework to allow any European bank to open branches abroad. This process led to growing competition in the banking sector and a progressive increase in the ratio of private banks to public ones.

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