Crisis Cycle: Challenges, Evolution, and the Future of the Euro

Three leading economists provide a detailed study of the euro crisis of 2010–12 and suggest reforms to prevent something similar from happening again. The authors attribute the crisis to weak enforcement of the eurozone’s fiscal rules and the absence of a mechanism for restructuring unsustainable public debts. These shortcomings placed pressure on the European Central Bank to act as bond buyer of last resort, which encouraged government profligacy. The authors reject more radical reform proposals, such as creating a fiscal union that would transfer extensive budgetary functions to the European Commission or a model in which the European Union abjured all responsibility for national fiscal policies and problems. Instead, they propose that the European Central Bank narrow its mandate by lending to banks, not governments, and only against high-quality collateral. They suggest further integrating banking and capital markets, which would enable European banks to avoid the danger of excessive exposure to their home countries’ government bonds. Member states, the authors insist, should establish and fund a European fiscal institution to provide temporary financing to governments unable to roll over their debts, which would relieve the European Central Bank of the need to intervene and support them.