Making the Euro Whole

NEW YORK – The architects of the euro knew that it was incomplete when they designed it. The euro had a common central bank but no common treasury. This was unavoidable, because the Maastricht Treaty was meant to bring about a monetary union without a political union.

European authorities were confident, however, that if and when the euro ran into a crisis, they would be able to overcome it. After all, that is how the European Union was created, taking one step at a time, knowing full well that additional steps would be required.

With hindsight, one can identify other deficiencies in the euro of which its architects were unaware. The euro was supposed to bring about economic convergence, but it produced divergences instead, because its architects did not realize that imbalances may emerge not only in the public sector, but in the private sector as well.

After the euro came into force, commercial banks could refinance their holdings of government bonds at the discount window of the European Central Bank, and regulators treated government bonds as riskless. This caused interest-rate differentials between various countries to shrink, which generated real-estate booms in the weaker economies and reduced their competitiveness.