Skip to main content

reichlin 14_Juhari Muhade_getty images_ graphic Juhari Muhade/Getty Images

The Eurozone’s Real Weakness

A new eurozone crisis would most likely have a less uneven effect than in 2008 or 2011, not least because its largest economies are currently weak. But if a recession hits, policymakers will find it hard to mount an effective response.

LONDON – The 20th anniversary of the euro this year is a good time to reflect on the robustness of Europe’s monetary union. The memory of the last crisis, which began in the United States in 2008, is still fresh in the minds of Europeans: the eurozone suffered more than the US, with some of its members getting hit much harder than others. At a time when the eurozone is once again showing signs of a significant slowdown, it is important to understand what happened last time. Did we learn anything in the euro’s first 20 years that could help fight another recession?

The most popular narrative of the eurozone crisis relies on the economist Robert Mundell’s theory of an “optimum currency area” (OCA), which warns against establishing a common monetary policy in a federation of different states with different levels of economic resilience. This view emphasizes that eurozone members lack the exchange-rate flexibility that might help them respond to a negative shock. To make matters worse, because the European Central Bank targets the average eurozone inflation rate, its monetary-policy stance may not be suitable for all member states. In the weakest countries, this may lead to real interest rates above the level required for full employment.

Another narrative focuses on financial fragility. In good times, some eurozone countries build up excessive leverage because of relatively low real interest rates – partly a consequence of the ECB’s one-size-fits-all monetary policy. In countries with weak institutions and poor governance, this can lead to a loss of competitiveness and excessive consumption. A crisis would then be nastier than normal, triggering a fall in asset prices and debt defaults, followed by a period of deleveraging and weak demand.

We hope you're enjoying Project Syndicate.

To continue reading, subscribe now.

Subscribe

Get unlimited access to PS premium content, including in-depth commentaries, book reviews, exclusive interviews, On Point, the Big Picture, the PS Archive, and our annual year-ahead magazine.

https://prosyn.org/qwYFdQD;
  1. benami155_ Ilia Yefimovichpicture alliance via Getty Images_netanyahu Ilia Yefimovich/Picture Alliance via Getty Images

    The Last Days of Netanyahu?

    Shlomo Ben-Ami

    In Israel's recent parliamentary election, voters stopped Prime Minister Binyamin Netanyahu's leadership of the country toward xenophobic theocracy. But Israel now faces a period of political deadlock, and it remains to be seen whether Netanyahu really will be politically sidelined.

    2
  2. oneill66_getty images_world Getty Images

    The Return of Fiscal Policy

    Jim O'Neill

    With interest rates at record lows and global growth set to continue decelerating, there has rarely been a better time for governments to invest in infrastructure and other sources of long-term productivity growth. The only question is whether policymakers in Germany and elsewhere will seize the opportunity now staring them in the face.

    1

Cookies and Privacy

We use cookies to improve your experience on our website. To find out more, read our updated Cookie policy, Privacy policy and Terms & Conditions