The origins of the euro crisis and theneed for economic coordination in acurrency union
EUIJ-Kyushu, First Annual International Conference –European Challenges for Overcoming the Crisis,
3 March 2012
F. Rawlinson, Kwansei Gakuin University

1Origins of crisis, need for economic
coordination - contents
Origins of euro crisis
1. Starting point of Emu v. theoretical optimum,
governance system, unforeseen risks
2. Practice of governance, rules revision
3. Onset and spread of the crisis: reassessmentof risks in markets, rising interest rates,
contagion, banking crisis
4. Lessons for economic governance2Origins of crisis, need for economic
coordination - contents
Need for further economic coordination
1. Macroeconomic surveillance, action on
imbalances, structural measures to enhancecompetitiveness,
2. Fiscal coordination, reduction of debt burden
3. Facilitation of fiscal discipline throughmarkets, banking regulation/ recapitalisation
4. Crisis management, restructuring
3Origins of crisis, need for economic
coordination - contents
Further questions and observations
1. Will austerity work?
2. Is gap between core and periphery too great
for a currency union?
3. Role of economists and commentators
4. In defence of the euro and eurozone
leadership4Origins of euro crisis
1. Starting point of Emu not optimal
Monetary union without fiscal/political unioni. No taxing powers, no treasury, no
spender/borrower of last resort
ii. Insufficient powers of economic/fiscal policy
coordination
Limited labour mobility; labour market
rigidities
Disparate economic structure between coreand periphery countries
5Origins of euro crisis
1. Governance system
Excessive deficits procedure focused on
deficits, not reduction of debt burdensNo differentiation of capital/consumption
spending, or according to debt burden
Lack of emphasis on structural economic
reform and competitivenessNo crisis resolution mechanism
Political enforcement
6Origins of euro crisis
1. Unforeseen risks
 Low interest rates and equal treatment of bonds by
ECB could lower the risk perceptions of markets
 This could encourage large private-sector imbalances
to build up beween core and periphery. Government
spending sprees and credit-fuelled booms in the
periphery were financed by the recycling of the core
countries’ surpluses.
 When the inevitable correction came, these
imbalances would create risks to public finances in the
periphery and to banks of core countries.
 Unsustainable financing of the private sector leads tounsustainable fiscal positions.
7Origins of euro crisis
1. Private imbalances

8Origins of euro crisis
1. Private imbalances (2)9Origins of crisis
2. Practice of governance 2000-08 –Stability and Growth Pact
Political decisions to avoid sanctions, even on
countries in repeated breach (Greece,
Portugal)Insufficient scrutiny of public accounts dataInsufficient macro-economic coordination tocounter the risks caused by private sector
imbalances
10Origins of crisis
2. Practice of governance 2003-05 –Revision of Pact

Revision “sent the wrong signal” (H. van
Rompuy)Sensible adjustments to improve flexibility,
but also missed opportunities for
improvement: differentiation
capital/consumption spending, greaterattention to debt sustainability, inducing
market differentiation of interest rates

11Origins of crisis
3.Onset of crisis: reassessment of risks,rising interest rates

Revelation of true size of Greek deficit
Bursting of bubbles in Ireland and Spain and rapid
re-emergence as public deficits; Irish bankguarantee
Markets reassessed risks on peripheral countries’
debt - constantly rising interest rates and yields,
credit rating downgradesShutting out from markets, need for bail-outs and
ECB market support (bond-buying, bank liquidity
loans)

12

Origins of crisis
3.Contagion, banking crisis
Contagion: expression of market dynamics(readjustment to risk perceptions)Natural correction, controllable only by actionthat restores market confidence (but what?)and faces the inevitable (defaults)
Euro crisis was always partly (mainly?) abanking crisis, caused by unwise lending(recycling of surpluses of core countries) andundercapitalisation of European banks
13Origins of crisis
4. Lessons for economic governanceDeeper economic policy coordination, including
macroeconomic surveillance and action on
private imbalances (trade deficits and surpluses,
borrowing and credit), not just public financesDeeper economic integration (single market)
Link to banking/financial market regulation
Provision for default
More independent enforcement
Crisis management tools
14

Economic policy coordination
1.Macroeconomic imbalances Surveillance of and action on private-sector imbalances in
conjunction with fiscal positions
 Coordinated across eurozone as a whole Issues:
1. What action by surplus countries?
2. To start when? (after end of current crisis – whenausterity/deflation in peripheral countries will haveworked (?) - or before?)
3. Growth
4. Sovereignty, means of coercion, decision-making
structures
5. Eurobonds as quid pro quo?
15

Economic policy coordination
1.CompetitivenessInternal structural reforms : more flexible labour
markets, entepreneurship, reduction of public
sector, productivity, pensions
“Europe 2020” strategy
Single market
Issues:
1. Will Greece (Portugal?) ever catch up?
2. Sovereignty, coercion?
3. Need for prior debt relief?
16Economic policy coordination
2. Fiscal coordination, debt reduction
 Focus on debt reduction
 Coordination of fiscal policy across eurozone as awhole
 Regard to type of spending, existing debt burden,
economic cycle
 Issues:
1. Sovereignty, coercion (prerogatives of national
parliaments, coordination of individual fiscal
positions, inclusion of taxation/social policies?)
2. Decision-making structures
3. Eurobonds as quid pro quo?
17Economic policy coordination
3. Facilitating discipline throughmarkets

No false signals on risk
Avoid placing excessive restrictions on markets
Transparency (e.g., bank stress tests)
Unity in policy statements, candour about
disagreements
Issues:
1. Governance machinery facilitating strong
leadership18

Economic policy coordination
3. Banking regulation
Recapitalisation of exposed banks
European-level regulation, including systemicrisks
(Bank-funded?) resolution mechanism,
emergency funding provisionIssues:
1. Split of mainstream banking serving real
economy from own-account securities dealing(to avoid “too big to fail” situations)
2. Enforcement of regulatory authority decisions
19

Economic coordination
4. Crisis management, restructuring
Permanent crisis management fundProvision for restructuring/default
Issues:
1. Crisis management vehicle to take over liquidity
funding, market support from ECB, to become
lender of last resort?
2. Restructuring of debts of further peripheral
countries (Ireland, Irish bank guarantee)
3. Terms of rescue loans, fiscal transfers
20Further questions and observations
1. Will austerity work?
Need for a foreseeable exit (light at end or
tunnel)Need for quid pro quo : action by core countries
to alleviate problems of periphery (eurobonds, astrong enough “firewall”, commitment tounlimited bond purchases, economic stimulus)
Issues:
1. Growth
2. Risk of democratic breakdown, inability tocomplete austerity programme21

Further questions and observations
2. Is the gap too great?
Will Greece (Portugal?) ever catch up?
Can (temporary) exits be managed?
Issues:
1. Need to learn from successes of othercountries in modernising their economies,
adjusting to crises
2. Need for temporary help, fiscal transfers

22Further questions and observations
3. Role of economists andcommentators

Irritating but useful (M. Wolf, W. Münchau, J.
Pisani-Ferry, P. Kruger, P. de Grauwe, “TheEconomist”)
Include respected establishment figures (P.
Sutherland, M. Monti, G. Soros)
A complex, intractable problem needs manyheads to help find a solution

23

Further questions and observations
4. The euro and eurozone leadership
Euro avoided even worse turmoil in financial
crisis
Has provided ten years of relative calm andprosperity for eurozone
Eurozone leadership simultaneously facing
recession and fiscal deficits in their economies
already weakened by financial crisisA simultaneous fiscal and banking crisis
24

Thank you for your attention

25

Francis Rawlinson, Kwansei Gakuin University
The origins of the euro crisis and the need for economic coordination
in a currency union
EUIJ-Kyushu, First Annual International Conference on‘European Challenges for Overcoming the Crisis’, 3 March 2012
Introduction
My talk will be about the origins of the euro crisis and the need for further economic
coordination in the eurozone if it is to be able to avoid and cope with such crises moreeasily in future.
First I deal with the origins (Slide 2). The starting point of economic and monetary
union was not ideal. The European Union is not sufficiently integrated in a number ofareas compared to the optimum situation for a monetary union. In hindsight, thedesign of the governance system was flawed, the implementation was lax, and therevision of the system in 2005 showed complacency and sent the wrong signal tomarkets, which had yet to awaken to the risks created by the imbalances that had
developed. When the crisis broke, the reaction from markets was as violent as theirprevious behavior had been placid. Deficit countries faced rising interest rates on theirborrowing, debt downgrades and were rapidly shut out of markets. There wascontagion, a domino effect, with one country after another being affected. And thenature of the crisis became more and more clearly a banking crisis, rather than a debt
crisis, caused by unsustainable private imbalances within the eurozone.
I try to draw together some lessons from these events. The main thing we need for thecurrency union to survive is wider and deeper economic coordination.
Next (Slide 3), I will deal with the ingredients of that economic coordination: more
extensive macroeconomic surveillance and coordinated action to deal with private
imbalances reflecting differences in competitiveness; deeper and more subtle
coordination of fiscal policy, seeing the eurozone as a whole and focusing on longerterm reduction of debt burdens more than on deficits; using the markets to induce
fiscal discipline, and banking regulation including recapitalization; and finally crisis
management tools involving the possibility of debt restructuring.
I will end my talk (Slide 4) with some reflections on current key questions, which
other speakers will no doubt take up later, such as: will austerity work without fiscal
transfers to the countries currently in the “intensive care ward”? Are some countries
realistically capable of adjusting their economies sufficiently to remain within thecommon currency without it becoming a transfer union? The role of economic
commentators and the media: helpful or just irritating? Finally, I offer somereflections on the benefits of the euro and in defence of the eurozone leadership,
which is widely criticized for its efforts to solve the crisis.

Starting point – insufficient economic integration; an inadequate governancesystemThe starting point of economic and monetary union (Slide 5) was not optimal judging
by the criteria developed in the optimum currency area theory. First of all, it was amonetary union without fiscal union, which means in effect political union. The EU
has no taxing powers. Its budget – customs duties and direct contributions from
Member States – is around 1% of GDP, far less than the USA, whose federal budget
is 18% of GDP. It has no treasury to provide fiscal transfers to states in crisis. It has
no spender or borrower of last resort. If the European Central Bank has reluctantly
begun to fulfil that role, it was and is not in its mandate.
The EU has insufficient powers of economic and fiscal policy coordination. Member
States have been determined to hang on to their sovereignty in these areas. We only
have a common VAT system; the rest of taxation is uncoordinated and subject tounanimous voting in the EU Council. Social security systems are still a nationalpreserve. This means that progress on integrating tax and social security systems is
painfully slow. Member States jealously guard their sovereignty over fiscal policychanges. It is one of the few areas where their sovereignty is almost untouched byintegration. But greater coordination of fiscal policy is vital for monetary union.
Labour mobility between countries of the European Union is very limited, largely due
to language and cultural differences. So that is not an answer to recessions. And there
are rigidities in labour markets in some countries, which make it difficult for them toregain lost competitiveness through labour cost reductions. There is a north-south
divide in this area: the north, led by the UK, with flexible labour markets; the south –Spain, Portugal, Italy and Greece – with rigidities.
The economic structure of eurozone countries is disparate. Most are modern andcompetitive with a varied economy, but a few on the periphery (Greece and Portugal)
are relatively one-sided (primary production competing with developing countries,
textiles and tourism).
Speaking of course in hindsight, the governance system for the euro (Slide 6) was
flawed in several respects. It focused overly on deficits (the 3% of GDP limit) and notenough on reduction of the overall debt burden, which in some countries was wellover 60% and, after the introduction of the euro, was increasing again. The nature of
deficits, for spending on capital or consumption, was not taken into account; nor was
account taken of the debt burden – if this was low, arguably bigger deficits should be
tolerable. There was little emphasis on competitiveness and structural reform. There
was no crisis resolution mechanism – no provision for emergencies and no bail-out
fund (indeed the rules forbade bail-outs). And, above all, sanctions were to be
enforced by the very politicians whose countries’ policies were to be subject to the
sanctions.
Private-sector imbalances
There were major risks totally unforeseen by the governance mechanisms (Slide 7).
Firstly, the uniformly low base interest rates in the eurozone set by the ECB could
dull the sensitivity of the markets to differences in economic performance, reflected inbalance of payments deficits. Commercial banks could refinance their holdings ofperipheral countries’ government bonds at the discount window of the ECB andregulators treated such bonds as risk-free. The low interest rates could lead tounsustainable borrowing, by the public or private sectors, or both, in the lesscompetitive countries that had balance of payments deficits. This could result in big
private sector imbalances developing. And it was not anticipated that the private
imbalances would switch to fiscal imbalances when bust followed boom and thefinancial markets woke up.
Data assembled by the IMF and reported in the Financial Times early in 2010 show
the size of these imbalances in 2006 (Slide 8). Germany had a current account surplusof 6.5% of GDP and the Netherlands a current account surplus of 9.4%, while Spain,
Ireland, Greece and Portugal had deficits. Spain’s deficit was 9% of GDP. In Spainand Ireland in particular, credit-fuelled private property bubbles had developed. Note
that, unlike Germany and France, which had budget deficits, Spain and Ireland’s
government budgets were in surplus. Thus, the later troubles of Spain and Ireland
were not caused by fiscal deficits, subject to the rules of eurozone governance, but byprivate imbalances, which were not monitored by the eurozone. Portugal and Greece,
however, had budget deficits as well as current account deficits.
After the crash, there was a sharp change in the private sector spending-income
balances in the peripheral countries. Spending was reduced and the private balances
became positive. And what happened to the previous private-sector imbalances?
These resurfaced as large public sector deficits (Slide 9), as a result of lower tax
receipts and increased public spending on benefits after the crash.
Operation of the governance system in practice; revision of the Pact
How did the governance system (the Stability and Growth Pact) work in practice?
(Slide 10). First, the enforcement of the pact was lax, because it was left to politiciansof the countries that were supposed to be the subject of possible sanctions. Member
States were reluctant to apply the Excessive Deficits Procedure to their colleagues. So
the procedure never led to actual sanctions being imposed on any Member State forbreaching the rules of the Pact. Secondly, there was insufficient scrutiny of public
accounts data. This allowed the chronic misreporting by Greece, which sparked theeuro crisis in late 2009.
Thirdly and most importantly, the degree of macro-economic coordination in the
eurozone was insufficient to counter the risks posed by private-sector imbalances due
to divergent economic performance. When the spending bubbles burst, these risks
would materialize as large fiscal deficits in the peripheral countries themselves and as
non-performing loan books held by banks, for the most part banks of the core
countries. At the end of 2009, banks headquartered in the eurozone had a total of$1,579bn in exposure to Greece, Ireland, Portugal and Spain. French and Germanbanks accounted for no less than 61% of that. And 84 % was lending to private
individuals; only 16% was public sector debt (Financial Times, 22 June 2010).
The revision of the pact in 2005 (Slide 11), according to the European Council
President, Herman van Rompuy, “sent the wrong signal” to the financial markets. It
reinforced their complacency about differences in economic performance, gaps incompetitiveness, and the build-up of imbalances. The revision made a number of
useful improvements to the rules to improve flexibility, such as the extension ofdeadlines for adjustment. But it ignored other important improvements that weresuggested at the time. One of these was the differentiation of deficits between capitaland consumption spending or according to a country’s overall debt position. Anotherwas introducing variation in the treatment of government bonds by the ECB
according to country’s debt position. For example, the ECB could have announced
that it would guarantee a lower proportion of the bonds of countries with high debt
burdens. This could have been a useful signal to markets, inducing them to revise
their risk perceptions about peripheral countries’ debt and start raising their interest
rates.
Onset of the crisis
The crisis had already begun with the bursting of their property bubbles in Ireland andSpain (Slide 12) in the wake of the financial crisis in 2008-9. Recessions also beganin Greece and Portugal. The peripheral countries’ fiscal positions sharply deteriorated.
Ireland guaranteed the liabilities of six Irish banks in September 2008. This increased
the contingent risk to its public finances.
A reassessment by the financial markets of the risks attaching to peripheral countries’
debt was thus well under way when the incoming new government in Greece revealed
the true state of its public finances in late 2009.
The reassessment of risks had predictable consequences: constantly rising interest
rates and yields on government bonds, credit rating agency downgrades, and the
shutting out of the peripheral countries from financial markets. The yields on theirbonds rose to 6 % and more above those on German bonds, an unsustainable level.
The peripheral countries’ governments and their banks quickly became dependent onliquidity support from the European Central Bank. The ECB replaced the crisis
resolution vehicle which the eurozone system lacked. And more visibly, theperipheral countries Greece, Ireland and Portugal successively required emergency
loans from the EU and IMF or from the hastily established European Financial
Stability Fund.
The spread of the crisis, or contagion (Slide 13), was a natural expression of market
dynamics, not the result of “speculation”. Risk perceptions had been complacent; thereassessment entered successively new areas as risks became clearer, particularly
those concerning the banks. The halting reaction of the eurozone leadership did not
help, but there were mitigating circumstances for their lack of immediate action,
which I will go into later. Contagion can only be halted by action that restores market
confidence and faces unpalatable facts. Such facts were the undercapitalization of thebanks that had funded the credit booms and the need for a restructuring of Greek debt.
Unfortunately, the initial response to the crisis was not decisive or realistic enoughwith regard to these facts to restore market confidence. The underlying banking crisisand the need for a restructuring of Greek debt were not admitted until a year and ahalf later in mid 2011.

Lessons for economic governance
What lessons has the crisis taught us regarding the system of governance required forthe currency union to work? (Slide 14)
First, we need deeper economic policy coordination in the eurozone – “economic
governance” not just monetary governance. The economic governance must coverdestabilizing macro-economic imbalances between eurozone countries, reflected incurrent account surpluses and deficits and in lending and borrowing balances. The
previous exclusive focus on public finances proved insufficient.
Second, the economic structure of some peripheral countries compared with theadvanced core is difficult to accommodate within a currency union. There is no
system of fiscal transfers in the eurozone and there are no automatic stabilizers (lower
tax transfers, bigger receipts from federal programmes) like in the United States. So
the peripheral countries with chronic competitiveness problems like Greece andPortugal need to catch up to the standard of development of the core in order to stayin the currency union. This also applies, to a lesser extent, to Spain and partly to Italy.
Ireland is a special case; its problems are largely due to the banking crisis.
The only way the problem countries can improve their competitiveness is throughdeeper economic integration with the markets of the core countries through market
opening, restructuring and modernization.
Some of the eastern European member countries also have relatively backward
economies that at present would be incompatible with sharing a single currency withGermany and France. Presumably, however, the eurozone leadership will be more
careful in future about admitting such countries in the first place.
Third, the economic governance of the eurozone must be conducted in close
cooperation with banking and financial market regulation. The crisis has shown thatsovereign debt and banking problems are inseparable and must be treated together.
This leads on to the fourth requirement, the provision for default on eurozone
government bonds. Markets can act as a strong discipline on governments’ behaviour.
But this is only the case if they are induced to make responsible risk assessments as tothe security or otherwise of their investments. They will only do so if the implicit
guarantee of all government debt is removed.
Fifth, enforcement should be made less political and more independent. This is one of
the most difficult requirements. It requires a change in mentality towards a
consciousness of the interdependence between one’s own country’s economic
decision-making and that of one’s partners and a willingness to adjust preferred
policies to prevent or alleviate problems in partner countries.
Finally, permanent crisis management tools are needed to restore calm on financial
markets through emergency liquidity help and market support.
Another issue that emerges in the discussion of several of these requirements is thequestion of eurobonds.

The ingredients of economic coordination: macroeconomic imbalances
I will now go into each of these requirements in turn and highlight certain questions
that they raise. I am not going to try to pass judgment on whether the measuresalready adopted or proposed by the eurozone leadership fulfil these needs.
First, concerning macroeconomic imbalances (Slide 15), we must be realistic about
the fact that collective, coordinated action on imbalances is going to be extremely
difficult to achieve. It requires a fundamental change in the mindset of governments
and national parliaments, used to determining economic policy in almost total
independence. Here are some of the difficulties:
1. It is difficult for Germany to admit that its current account surpluses andunwise lending by its banks have been a contributory cause to the crisis. On
the other hand, Germans may be persuaded by the argument that they havebenefited from the euro and the euro is therefore worth saving and that
therefore some further sacrifices in the economic sphere should be made.
These will include action to reduce surpluses through stimulation of domestic
demand and possibly accepting losses at German banks through further debt
restructuring of peripheral countries’ debt to make their debt burdens
sustainable.
2. This raises the question of whether the action on imbalances can wait until thecurrent austerity programmes in peripheral countries have run their course.
Many outside commentators doubt whether in some of these countries theausterity programmes can work. They think further action to alleviate theirdebt burdens is necessary.
3. It is also the prevalent opinion outside the eurozone leadership andgovernments that there is unlikely to be significant growth in the eurozone
periphery in coming years. This will make it difficult for them to put theirfinances back on a sustainable footing under the present austerity programmes,
without further help and economic stimulus by the core countries.
4. The ingrained habits of national sovereignty make genuine coordination ofpolicy and shared sacrifices hard to achieve. This raises the question of thedecision-making bodies and procedures. How independent of national
governments will they become?
5. The governments of the peripheral countries, the opposition in Germany itself,and economic commentators, want the German government to express its
solidarity with its partners by agreeing to the issue of common eurobonds.
This could be a kind of compensation for the pain of austerity, could calm themarkets and could help peripheral countries through the crisis.
Structural reform in the periphery
Internal structural reforms are needed in the peripheral countries for them to regain
competitiveness (Slide 16). They need to reach the standards of labour market

flexibility, productivity, efficiency in the public sector, and pension arrangements
found in the core countries. Several parts of the Europe 2020 Strategy can help them
improve competitiveness. I would single out the targets for raising the employment
rate to 75% and the share of renewable energy to 20%. More determined applicationof single market rules to liberalize energy and other markets and in the public
procurement field can also help.
The issues here are: Can Greece ever catch up? With great respect to my Greek excolleagues in the Commission, the Greek administration has often been the odd man
out in the EU, finding it very difficult to adapt to disciplines accepted by all the othermembers. Secondly, the sovereignty issue arises again, for example with regard tochanges in the legal and tax system that hamper competitiveness. How can Greece beforced to speed up reforms? Finally, I come back to the question whether Greece cansurvive the current austerity programme without further help (or will it have to leave
the euro altogether?). The same doubts and considerations apply to Portugal and, to alesser extent, Spain.
Fiscal coordination
The future fiscal coordination in the eurozone (Slide 17) should focus on debt
reduction. It should also be more subtle and intelligent, regarding the purpose of
deficits, the point in the economic cycle and debt reduction goals. As genuine
coordination of the policies of countries bound by a common currency, it should lookat the eurozone as a whole.
This would mean a real possibility of bringing about adjustments to national policies
where the interests of the common currency require, possibly against the will ofnational parliaments. A real transfer of sovereignty is involved. Taxation and
expenditure are one of the few remaining areas over which national parliaments still
have virtually exclusive control. In the Member States there is already a feeling thatnational parliaments are unable to assert proper control of EU action. To avoid
aggravating this, very sensitive handling will be required. Again, concrete advantages
in return, such as eurobonds, might sweeten the pill.
Discipline from financial markets; banking regulation
The crisis would have been less serious if financial markets had played their role indisciplining private and public spending in the early years of the euro’s existence(Slide 18). Future eurozone governance should harness the markets to perform theirproper role. Therefore, different levels of risk should be made clear, and reassuring
but false signals should be avoided. There should be transparency of information
regarding risk. An example of the opposite policy was the initial reluctance to publish
the bank stress tests, for fear of unsettling the markets. Politicians should not hide
their disagreements but there need to be greater efforts to speak with one voice once
decisions have been taken. The governance machinery should facilitate strong
leadership and summits between the “Merkozy” duo should avoid pre-empting
decisions by the established decision-making bodies.
Banking regulation should move hand in hand with fiscal and economic coordination(Slide 19). The recapitalization of the most exposed banks, based on stress tests usingreasonable risk assumptions, is under way. New European-level regulatory machinery,
including on systemic risks, has been set up. But decisions are still needed on thechannel for emergency liquidity funding for banks, if the ECB is no longer to fulfil
this role, and on the resolution mechanism for bank failures and how it is to be funded.
A European solution to the “too big to fail” situation of mega-banks comparable to
the Dodds-Frank Act in the US would be preferable to piecemeal national legislation.
Finally, there is the question of the enforcement of banking regulatory authority
decisions on banks.
Crisis management
Permanent machinery for crisis management with adequate “firepower” is needed(Slide 20). This is already underway with the enlarged European Financial Stability
Facility and the European Stability Mechanism. They are eurozone treasuries inembryo. The agreement on building the risk of restructuring into future bond issues
seems reasonable, but this risk should be minimized by a governance system that ismore effective in preventing default situations. There still seems to be much work to
do done on the division of labour between the crisis management facility and theEuropean Central Bank. Should the crisis management vehicle take over liquidity
funding and market support from the ECB? Should it have a bank licence and offer
unlimited support, be a lender of last resort?
The question of whether a restructuring of the debts of further peripheral countries(Portugal, Ireland) will be necessary is still open. So is the question of the terms ofrescue loans – are the IMF-style conditions too harsh and will they ultimately be selfdefeating? Will further help be needed?
Final remarks
In conclusion, I would like to repeat a few of the messages I have tried to give in mypresentation.
1. Will austerity work?(Slide 21) The countries in the “intensive care ward” needto see some light at the end of the tunnel of austerity, some foreseeable exit
when the pain will be over. The core countries that are imposing theirdiscipline on the peripheral countries should offer something in return to easethe peripheral countries’ plight: eurobonds, a strong enough firewall to reduce
the liquidity difficulties of the solvent but illiquid countries, a commitment tounlimited bond purchases for these countries, and economic stimulus in thecore countries. There needs to be action to restore growth. And the risk of abreakdown of democratic institutions in the periphery and their inability tocomplete the austerity programmes must be taken seriously and contingency
plans (for example, for exiting the euro) made.
2. Realism is needed when assessing the chances of success of the austerity
programmes and the chances of Greece, for examples, ever bridging its
competitiveness gap (Slide 22). Can exits from the euro-zone be managed?
Could such an exit be temporary? I have no doubt the European Commissionis thinking hard about this. Personally, I am optimistic that most of thecountries now in difficulties can pull through, provided the core countries playtheir part in helping them to adjust. The Baltic states are often cited as
examples of how small countries can adjust to crises. There are many othercases of countries radically modernizing their economies. The “Celtic Tiger”,
Ireland, used to be referred to as an example to emulate, before the euro crisis.
3. Economic commentators have, in my opinion, played a useful role in the euro
crisis, although their criticisms have no doubt been irritating to the eurozone
leadership (Slide 23). Among the most strident of critics has been the British“Economist” magazine, but arguably it has mostly been proved right. The
British “Financial Times” has offered a wide variety of views and has invitedrespected elder statesmen to comment. The lesson that has emerged is thatmany heads are needed to solve such an intractable and complex problem
4. In defence of the euro (Slide 24), the existence of the single currency avoided
even worse turbulence during the financial crisis of 2008-9. The euro provided
ten years of relative calm and prosperity. It can in my opinion continue to doso, provided the right decisions are taken by the leadership. In defence of theleadership, they were faced with a simultaneous sovereign debt and banking
crisis, coming hard on the heels of the financial meltdown of 2008-9 which
had severely weakened their economies. Their populations were themselvessuffering austerity and reluctant to help. However, arguably the eurozone
leadership has been at fault in failing to impress sufficiently on their
populations the benefits the euro has brought to Europe.