Among these potential mechanisms, particular importance was accorded to the so-called “competitiveness channel”, which works as follows: when an economy’s inflation rate stands systematically above the average for the rest of the area, the very loss of competitiveness involved – or, what amounts to the same, the relative rise in the cost of output in that economy – tends to reduce demand-side pressures and ease the tensions on prices that led to the initial slippage. However, for this channel to work economies should, inter alia, be adaptable and sufficiently flexible, something which, for social and political reasons, is evidently not easy to achieve. It was also thought monetary union membership would prompt greater discipline in economic policy management. It was assumed that, if a Member State’s management of the economic instruments available to it was inadequate, the subsequent adverse effects on its growth and employment-generating capacity would lead international investors to demand greater returns for investing in the country, or even to freeze such investment. The subsequent tightening of financing conditions would discipline economic agents and ultimately redress economic management. But this mechanism did not work because financial markets, rather than punishing divergences, instead financed excesses, contributing to exacerbating tensions. Unsurprisingly, then, the crisis has called into question the consistency of the institutional arrangements underpinning the euro. The solution would involve a reformulation of the initial project, geared to fuller integration.

The Chinese government was not willing to allow its currency to float freely and the exchange rate against the US dollar was managed. This disabled an important stabiliser and contributed increasing world trade imbalances. Long-term interest rates remained low in spite of substantial monetary policy tightening in the US between 2004 and 2006. International organisations such as the BIS, OECD, IMF and others noted on more than one occasion that growing imbalances in the world economy were a source of concern. But economic policy decisions are the prerogative of national governments. Given the policy pursued by China, there were probably limits to what monetary policy in Western countries could in reality achieve in terms of rolling back these forces. Increased private saving in the US and other deficit countries would probably have required monetary policy tightening sufficient to push up long-term interest rates. Alternatively, a substantial increase in public sector saving would have been necessary. Both alternatives would probably have led to an economic policy driven downturn. It is demanding to pursue such a policy based on the proposition that a crisis might occur in the future. Improved financial regulation would probably have reduced the severity of the financial crisis. Regulation and insurance have similar features: in most cases an annual premium must be paid in the form of slightly lower growth. This occurs because capital is not allowed to flow entirely freely to the highest yielding vehicles. In return, regulation can counter the build-up of financial imbalances.