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date: 21 August 2017

# The Eurozone Crises

## Summary and Keywords

Even the most critical observers of the creation of the euro found some nice words on the occasion of its 10th anniversary. And yet it needed only a marginal event like the announcement of the newly elected Greek government that the previously stated public debt ratio was gravely miscalculated to move the euro into a critical crisis zone. Swiftly the attention of private credit markets turned to more member states of the eurozone, only to eventually detect that financial stability of banks did not meet sustainability indicators.

What is often labeled as “eurozone crisis” is better understood by a political-economic forensic analysis that rather speaks of eurozone crises. First, the causes for financial and then sovereign debt crises of Greece, Spain, Portugal, and Ireland (to name only the most prominent) differ fundamentally. They were triggered by the same events but caused by differing factors. Second, it is a crisis of economic governance, and thus an institutional crisis that needs fundamental institutional changes. Third, it is a crisis of political leadership.

The overlapping character as well as the interplay of those three dimensions hampers a proper understanding of the dynamics of the processes that started in 2010. By differentiating between national crisis causes, triggering mechanisms, policy responses, and multi-level crises management, we suggest a comprehensive analytical framework that may guide current as well as future research in the operating of an incomplete currency union.

# Introduction

The project of European integration has experienced quite a number of crises, and a widespread saying tells us that those crises actually strengthened rather than weakened the project. The eurozone crisis can be seen—to some degree at least—as one further crisis of European integration in so far as the common currency has become the core project of the European Union (EU) that in many ways shapes the present, as well as the future, of European integration. At the same time, the eurozone crisis and its corresponding national crises present a specific challenge that goes beyond the experiences of past integration crises, which were mainly political and were firewalled from economic crises. The eurozone crisis is as much an economic crisis as it is a political-institutional crisis, and, as this article argues, it has great potential to move the overall project of European integration into the abyss. Scholars like Schimmelfennig (2014) make the point that such a view is alarmistic at best and misleading at worst since the political responses to the eurozone crises show strong similarities with previous political crises in so far as they create active political responses that result in fundamental changes in governance structures and policies. In the case of the current crisis, the fundamental change he has in mind is presented by the total makeover of the established regime of economic governance. The eurozone, its various institutional components, and individual member states (particularly peripheral economies that became trapped in sovereign debt crises) responded to the crisis by changing policy. The suggestion that a combination of political will and adequate policy tools can restabilize the eurozone (Verdun, 2011) is not without merits but—strangely enough, given the developments—lacks any sufficient understanding of the nature of the eurozone crisis. Such views seem to be driven by the idea that successful past crises management is applicable to the present and also the near future. In contrast to this unfounded optimism, this article argues that the reform of the existing regime of economic governance has not led the eurozone back to a sustainable growth path. On the contrary, I argue that as an outcome of the crisis and its political management, there is a realistic chance that the eurozone will get stuck on a suboptimal growth path.

Arguably, the eurozone crisis—using this singularized term as a catch-all category that allows us to summarize the various national forms of crises—can be categorized as the greatest failure in the history of European integration in terms of economic and social costs (Frieden, 2015). The depth and character of the crisis mushroomed a eurozone crisis literature that is difficult to keep up with. And yet, seven years after the open outbreak of the eurozone crisis, the debate about the concrete character, origins, and ongoing nature of the crisis has not come to a conclusive consent. This has led analysts like Jones (2015) to the conclusion that the crisis is overdetermined. This view is, to some degree, also expressed by the most ambitious attempt of crisis explanation to date. This explanation is produced by a rather diverse group of economists who present what they call a “consensual crisis narrative” (Baldwin et al., 2015). However, the analytical price for such consent seems to be a lack of precision. As a matter of fact, even determining the correct term for the eurozone crises is a difficult undertaking. For example, the term sovereign debt crises is undermined by the fact that the bulk of economies who had to ask for a bailout were economies with relatively low levels of public debt ratios at the onset of the crisis. On the other hand, talking about the eurozone crisis neglects the simple empirical fact that not all national crises are equal and, moreover, that some economies outside the eurozone share commonalities with crises of eurozone member economies. And talking about the eurozone crisis neglects the fact that economies outside the eurozone were entering a crisis cycle simultaneously with eurozone members.

This article seeks to establish some order within the cacophony of the crises discourses by presenting and discussing the most prominent analyses to emerge in the last several years. I then suggest a sequential approach that starts out with the root cause(s) of the crisis and go on to discuss the crises dynamics and crises-enhancing effects. This analysis implies that a proper understanding of the crisis requires combining economic and non-economic factors.

# Eurozone Narratives

The crisis of the euro did not come without warnings. As a matter of fact, quite a substantial number of economists, mainly of North American origin, made the point that a coming European monetary union would be plagued with many contradictions and tensions that would eventually lead the currency union and its members onto an inferior economic path (see Jonung & Drea, 2010). A leading voice of this camp was Martin Feldstein, who argued as early as 1992 that a common European currency would not be sustainable, if only for the reason that there would be no way to contain Germany and its potential combination of economic, political, and military power (Feldstein, 1992). Krugman (1998) pointed to the institutional weaknesses of the common currency, not least the problem of creating a common currency without the intention of launching a simultaneous political unification. Tobin (1998) argued that the lack of a central fiscal authority, labor markets with sticky wages, and the low level of labor mobility are factors that could lead to severe problems in the workings of the new currency. Much of this critical sentiment was based on what was seen as the seminal analytical contribution for a “optimum currency area” by Mundell (1961) that generated a prominent literature. Paradoxically enough, Mundell was not only seen by many as the “father” of the Euro, he also expressed strong views in favor of the new currency (Mundell, 1998),1 even though critics of the euro used exactly his “optimum currency area” analysis to argue that the euro would not be sustainable (see McKinnon, 2000). In particular, the stickiness of wages and the relatively low labor mobility were seen as weaknesses for a currency arrangement that by definition came with abandoning the exchange rate as a policy tool for member states. And yet, when the crisis hit, most of the skeptical analyses were poorly equipped to target the actual roots of the crises. As will be shown, the eurozone crisis is a crisis sui generis that then took on particular features of the general type of banking and financial crises. Moreover, the way the crisis manifested itself became the basis for a severe political misreading that resulted in problematic economic policy responses, which in turn changed the character and main traits of the original crisis.

The first 10 years of the common currency seemed to defy most of the critical arguments provided during the pre-euro period (Buti & Gaspar, 2008). For many observers it seemed that the actual economic development confirmed Frankel and Rose’s (1996) concept of the endogeneity of optimum currency area criteria. Rather than falling apart quickly, the eurozone presented itself as a monetary space within the EU that supported strong economic growth, particularly for peripheral economies. This was not least due to the astounding advance of intra-eurozone capital flows between current account surplus and current account deficit member economies, which provided the financial fuel for strong and long-lasting credit booms in peripheral economies. Rather than interpreting those intra-eurozone capital flows as potential crisis triggers, they were actually seen as confirmation of a functioning currency union where private markets arranged adequate capital flows between surplus and deficit economies. When the global financial crisis hit in 2008, the immediate concerns were about the implications on economic growth and external trade, as well as the stability of globally active domestic banks and financial institutions and, to a lesser extent, the viability of the eurozone. To a vast degree, the financial crisis was seen as the result of an overstretched and rather opaque financial industry of the United States, whose downturn was transmitted to Europe due to the strong global inter-connectedness of banking and finance activities. This sentiment was clearly expressed as follows:

The depth and breadth of the current global financial crisis is unprecedented in post-war economic history. It has several features in common with similar financial-stress driven crisis episodes. It was preceded by relatively long period of rapid credit growth, low risk premiums, abundant availability of liquidity, strong leveraging, soaring asset prices and the development of bubbles in the real estate sector. Stretched leveraged positions and maturity mismatches rendered financial institutions very vulnerable to corrections in asset markets, deteriorating loan performance and disturbances in the wholesale funding markets. Such episodes have happened before and the examples are abundant (e.g. Japan and the Nordic countries in the early 1990s, the Asian crisis in the late-1990s).

(European Commission, September 2009).

The European Commission, as well as its leading economists (Székely & van den Noord, 2009), were either not willing or not able to accept that this analytical description of the global financial crisis described the economic situation of the eurozone in 2008, nor did they foresee that the eurozone would become the next “episode” of a financial crisis. This can be seen as an act of ignorance since numerous structural features of the eurozone were similar to the global economy. Like the global economy, until 2008, the economic development of the eurozone was characterized by a massive polarization of current accounts of member economies. This polarization came with unseen capital flows from surplus to deficit economies, which eventually resulted in an enormous credit boom of the private sector within the receiving economies. Financial markets in general, and European banks in particular, interpreted the common currency as a monetary device that would stay forever and subsequently abolish any opportunity for national devaluations. Together with the strong anti-inflationary mandate of the European Central bank (ECB), this was seen as a huge reduction in currency risk that in turn stimulated intra-eurozone capital flows. Those flows resulted in sharp reductions of borrowing costs for peripheral economies and, thus, caused a convergence of nominal interest rates on a historically low level.

If we define the core of the eurozone as consisting of Germany, France, Austria, Belgium, and the Netherlands, then Figure 1 illustrates nicely the size of capital flows to the peripheral economies of Portugal, Ireland, Greece, and Spain. All states benefited strongly from the capacity of core economies’ banks to lend to the catch-up economies of the common currency zone that suffered—by the nature of the economic processes—from current account deficits. In this respect the eurozone did not differ at all from the global trend of building up large stocks of private debt of current account deficit economies that fed economic growth, but eventually turned into a credit bust. Simultaneously, the lending institutions made themselves—to varying degrees—vulnerable to the debt service capability of the lenders. What was genuine for the eurozone was that the launch of the common currency generated a compression of bond spreads in its periphery that encouraged “excessive borrowing by these (peripheral, kh) countries, domestic lending booms, and asset price inflation” (Hale & Obstfeld, 2016, p. 116). The flip side was the buildup of “inflated gross foreign debt liability and asset positions for core countries like Belgium, France, Germany, and the Netherlands” (Hale & Obstfeld, 2016, p. 116).2 Both processes increased the fragility of financial relations enormously. When the crisis hit, the core economies were confronted with potential banking crises, and the periphery had to deal with debt crises that eventually threatened their financial systems.

The bust was the outcome of a sudden-stop event that was triggered by the announcement by the newly elected Socialist government in Greece in October 2009 that its budget deficit would be twice as large as announced by the previous government and much above the Maastricht criterion of a maximum deficit of 3%.3 This announcement, in combination with the negative growth effects of the global financial crisis, alerted financial markets and encouraged them to have a closer look into the state of the eurozone, not only in regard to Greece but also in regard to economies that showed current account deficits financed by huge capital inflows. When the initial Greek attempts to handle the implications of the sudden stop of external funding ran into problems, and when it turned out that the eurozone institutions as well as its member economies were extremely ill prepared to deal with the emerging Greek debt crisis, financial markets began to fear that their reading of the “no-bailout clause”4 might not be accepted by the governments of the member states automatically. In other words, financial market actors started to doubt whether their implicit belief that governments would in times of emergency opt for system-stabilizing bailouts still holds. Thus, the sudden stop was complemented by a strong increase of national risk premiums that signaled the strong concerns of financial markets regarding the sustainability of current debt levels. In turn, the institutions of the eurozone and the member states decided to interpret the no-bailout clause in a creative way and thus to put Greece under bailout supervision. The EU-ECB-IMF program launched in May 2010 can be seen as the original sin of crisis management as it falsified the no-bailout clause and put the eurozone on a particular crisis management path that connected external debt with sovereigns and ultimately started to favor a project of austerity as the core of its crisis management (Orphanides, 2015). At the same time, the EU-ECB-IMF program perpetuated a particular conceptual view of the crisis’s origin as Greece’s obvious fiscal profligacy was generalized across the eurozone, and the best political remedy was to demand harsh fiscal austerity. This view was strongly supported by the prevailing ideological concepts of ordo-liberalism and neoliberalism, particularly on the side of European creditor agencies (Matthijs & McNamara, 2015).

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Figure 1: Total Lending from Core Economies to Periphery, 1999–2009, in %. (From Baldwin, et al., 2015.)

In a perfect world of efficient financial markets, the buildup of excessive debts would not have happened, as creditors would not only have perfect information about the present and the future but also would not have misinterpreted legal-financial rules like the non-bailout clause.5 Rather than acting as financial alert dogs that would execute market discipline on potential violators, financial market actors followed a herd behavior when they first underwrote decreasing risk premiums for peripheral debtors of the eurozone. This herding behavior was repeated after the outbreak of the global financial crisis when they turned their attention to the current account deficit economies of the eurozone and consequently increased risk premiums. This increase in sovereign risk premiums not only added to the economic fragility of the eurozone but also strengthened the already emerging view on the side of the European Commission and the member states of the eurozone that the developing liquidity crises of some member economies were the result of fiscal profligacy of the past. Even though this perception was not in concordance with the majority view of academic economists, or with the empirical facts, it still became the most powerful political narrative that guided further political action.

To simply characterizing the emerging eurozone crisis as a sudden-stop crisis due to an unforeseen loss of confidence on the side of financial markets is, to some degree, a misleading analysis as it does not explain the undercurrents for the loss in confidence; nor should the eurozone crisis be seen as a simple result of spillover effects from the global financial crisis. The global financial crisis provided a critical vortex to the eurozone crisis but was neither the trigger nor the actual cause. Neither did the drastic reduction of real interest rates trigger a credit boom that necessarily ended in a credit bust. De Grauwe (2010) rightly refers to the case of Italy that experienced a drastic reduction in risk-adjusted interest rates without experiencing a credit boom like other peripheral economies. Nevertheless, Italy also became part of the group of economies that experienced steep increases of risk premiums when the crisis began (Baldwin et al., 2015). Nor should the eurozone crisis be labeled as a sovereign debt crisis, as it was not the high level of public debt that actually caused the crisis. Taken as a group, the eurozone economies actually experienced a decline of the public debt ratio between 1999 and 2007 from 72% to 67%. In the same period, the debt ratio of private households increased from 52% to 70% of GDP, and financial institutions showed a rise of their debt ratios from close to 200% of GDP to more than 250% of the aggregated GDP. Spain and Ireland, who both were exposed to drastic increases of risk premiums, were able to decrease their public debt ratios in the same period from 60% to 40%, respectively, from 40% to 23% (De Grauwe, 2010). Only when financial markets were alerted about the economic situation of eurozone economies and political responses kicked in in order to deal with the fragile situation of national banking systems did the eurozone crisis begin to turn into a number of sovereign debt crises (Lane, 2012; Mody & Sandri, 2012). The literature seems to acknowledge this bifurcation process but only rarely delves deep into this issue, mainly because governments’ as well as creditors’ actions resulted in the socialization of private risks and thus in the sudden and enormous increase of public debt. Even though this increase was the effect and not the cause of the crisis, a lot of attention has focused on the public debt character of the eurozone crisis.

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Figure 2: Crisis Narratives

It is fair to state that the academic debate was more accentuated and skeptical against mono-causal explanations of the crisis then the political debate, which (wrongly) explained the crisis simply with fiscal profligacy of governments. And yet, even though a majority of scholars do not categorize the eurozone crisis as a public debt crisis,6 the academic debates still did not easily converge toward one crisis narrative but came up with quite a range of root causes (see Figure 2). Four narratives feature most prominently in these debates: (1) institutional flaws, (2) policy failures, (3) external imbalances, and (4) divergence in competitiveness. The arguments of these narratives differ, and so do the policy implications. At the same time it needs to be stressed that these narratives often overlap and are combined into what easily results in an analytical overdetermination of the eurozone crisis (Jones, 2015). In the best way this can lead to a multi-causal explanation of the crisis (Caporaso & Rhodes, 2016), in the worst way such a methodological procedure creates a level of arbitrariness.

The narrative of polarizing, or at least diverging trends, of price competitiveness has become quite popular, particularly in the early stage of the debates (see Salvatore, 2015). This narrative is driven by the argument that the lack of price competitiveness of the southern periphery of the eurozone resulted in increasing deficits of current accounts that were financed by capital imports (Sinn, 2014; Thimann, 2015). According to this view, the polarization of external balances was the result of diverging competitiveness trends, and thus not the cause of the crisis. The competitiveness narrative usually refers to unit wage costs (UCL) as key indicator of competitiveness, expressed as:

$Display mathematics$

where W is the nominal wage per worker, Y real GDP, and L the number of workers. Empirical data for this version of ULC clearly shows a strong divergence of competitiveness between the southern periphery of the eurozone and the rest of eurozone members. Consequently, the root of the eurozone crises is identified as a loss of competitiveness, mainly due to increases of nominal wages that far exceed the increase of productivity. This in turn leads to trade balance deficits and thus to unsustainable current account deficits and the piling up of external debt. As Hancké bluntly put it, “ relative ULC diverged, current accounts followed, and a balance of payments crisis ensued” (2013, p. 104) This straightforward-sounding diagnosis is not without problems, as Wyplosz (2013) and Rhodes (2014) demonstrated. According to this critic, ULC is an incomplete indicator as it implicitly claims that that firms of eurozone economies only compete with each other, and thus neglects that companies—to varying degrees—also compete with companies outside the eurozone. Rather than taking ULC as an indicator for international competitiveness, it seems preferable to refer to the real effective exchange rate. Still, representatives of the competitiveness narrative make ample use of diverging developments of unit labor costs and see this process as the root cause for the crisis. A popular version of this narrative refers to the role of wage moderation in Germany that assumingly resulted in a widening gap of price competitiveness and thus increased exports of Germany and increased imports on the side of the economies with relatively high increases in ULC (Bofinger, 2015).

The narrative of external imbalances does not contradict versions of the competitiveness narrative but suggests a different chain of triggers. According to the imbalance narrative, the launch of the common currency started a convergence of risk-adjusted nominal interest rates for bonds that then laid the groundwork for credit booms that put national economies on a higher growth path. This increasing growth changed labor market relations in favor of workers and thus increased nominal wages. Full-employment economies experienced increases in inflation at the same time and thus a reduced real risk-adjusted interest rate that additionally fueled the credit booms. According to this narrative, it is the integration of eurozone financial markets that created an equalization of interest rates on a relatively low level and then encouraged economic actors to make use of these opportunities. The demand for foreign credits was met by the increasing supply of financial resources on the side of current account surplus economies. Some authors explain the polarization of current accounts within the eurozone as the outcome of a successful mercantilist policy of Germany that went for a strategy of wage depression (Bofinger, 2015), whereas others (Chen, Milesi-ferretti, & Tressel, 2013) explain the divergence with increasing trade balance deficits of eurozone member economies with the rest of the world that required compensating external financing, which was provided by eurozone banks of surplus economies. Blanchard and Giavazzi (2002) presented empirical findings that highlight polarization within the eurozone current accounts started and that the correlation between national savings and national investment started to significantly decline. The latter was rightly interpreted as an intensification of financial integration that helped the catch-up processes of peripheral economies. At the time, though, the emergence of current account imbalances was not seen as a serious problem, mainly because in a catch-up perspective the accumulation of foreign debt would be canceled out by current account surpluses in the future. This view changed with the outbreak of the eurozone crisis, and the imbalance narrative turned into a “competitive story.”

One version of the imbalance narrative (Jones, 2011) makes the argument that the increase of intra-eurozone capital flows reflects differences in real interest rates due to strong differences in national inflation rates.; the identical nominal key interest rate set by the European central bank translated into relatively low real interest rates in high-inflation economies and relatively high real interest rates in low-inflation economies. Low real interest rates are an incentive to go into debt, whereas high real interest rates are an incentive to send capital to areas of higher yield. According to this narrative the “one-size-fits-all” mechanism of a currency union implied that the monetary policy of the ECB slowly but surely created the conditions for increased divergence. Between 1995 and 2008—this period includes the euro preparation years—the GDP deflator for Greece increased by 67%, for Spain by 56%, for Ireland by 53%, and for Portugal by 47%. The indicator rose during this period in Germany only by 9%, and the eurozone average increased by 26% (Sinn, 2014). It is this divergence in inflation rates that this version of the imbalance narrative identifies as the driving factor for intra-eurozone capital flows and, by extension, the pileup of unsustainable debts. In this regard, the eurozone suffered from an in-built institutional flaw that eventually prepared the ground for an endogenous crisis process.

The one-size-fits-all monetary policy of any currency union has been discussed from the outset of the euro debate. It is in the logic of a common currency that the central bank of such an entity can only set one, and only one, nominal short-term interest rate. Such a trait is not automatically a flaw, nor does it imply that member economies must end up on divergent economic paths. The latter depends also on the articulation between centralized monetary policy and national fiscal policies. Regardless, the crisis narrative of institutional flaws is rather powerful by providing two arguments. First, the narrow-minded mandate of the ECB and its lack of financial regulatory powers prevented the political control of the buildup of private debts and thus opened the path to an unsustainable financial situation. Second, even though the launch of the euro was pre-shadowed by the liberalization of financial markets, the project of a complementary banking union was not on the agenda (Giavazzi & Wyplosz, 2015). Even more powerful is another line of thinking, namely the argument that the eurozone crisis has been caused by the deliberate political undercutting of the Stability and Growth Pact, in particular by France and Germany. This story (wrongly) describes the eurozone crisis as a public policy failure (Beker, 2016) that has its root in the original sin of a political manipulation of established rules, and in this sense sees the crisis as the outcome of weak institutional rules which were easily reinterpreted by strong political and economic powers. Even though it is fair to state that both Germany and France violated the deficit criteria, it is a courageous step to make this violation a cause for the eurozone crisis. Policy failure is also being attested to the ECB, in particular at the very start of the emerging eurozone crisis when the central bank raised the interest rate in 2011 in fear of inflationary processes, and afterwards—in stark contrast to other central banks—was much too hesitant with its start of quantitative easing policies (Wren-Lewis, 2016). Again, it is fair to state that the ECB was badly prepared to deal with the emerging crisis, but rather than causing the crisis, it can be argued that actions of the ECB were critical for the management of the crisis.

# A Sequential Crisis Narrative

The problem with the majority of these crisis narratives is not that they are fundamentally wrong. Actually, most of them highlight particular mechanisms and triggers that are relevant. However, adding them up leads, as Jones (2014) argues, to an overdetermination. The alternative procedure, to look at each crisis of member economies separately, is no reasonable way out of this methodological trap. In this tricky situation, Shambaugh’s (2012) suggestion to understand the eurozone crisis as the result of three interlocking crises seems attractive: “The euro area is currently in a banking crisis, where banks face a capital shortfall, interbank liquidity is restrained, and future losses are uncertain. At the same time, it faces a sovereign debt crisis, where at least one country (Greece) will not pay its debts in full, and bondholders are displaying increasing concern about other sovereigns. Finally, it also faces a macroeconomic crisis, where slow growth and relative uncompetitiveness in the periphery add to the burden of some of the indebted nations” (Shambaugh, 2012, p. 158). Rather than identifying a root cause for the crisis, this narrative argues that it is all about the interlocking mechanisms that created a vicious circle. Therefore, this crisis is understood as the outcome of a number of temporally close to simultaneous and self-enforcing processes. This essay suggests a slightly different view by taking a sequential perspective (see Figure 3), which explicitly sees the eurozone crisis as a particular type of a balance sheet crisis that turned over sequences into sovereign debt crises. It is a typical balance sheet crisis since it was private households and the business sectors that experienced enormous increases of their debt-to-GDP ratios over the period of 2000 to 2009 (see data in De Grauwe, 2010).

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Figure 3: Sequential Crisis Approach

This approach splits the eurozone crisis into four sequences that build on each other. Rather than stating an automaticity of the sequences, the approach suggests that each of the sequences that follow the first sequence were to some degree avoidable or, in other words, were the results of deliberate economic-political actions. Sequence 1 is the period of the buildup of contradictions within the institutional architecture and regime of economic governance. This sequence begins with the launch of the common currency and is characterized by the steady buildup of private debt in economies of the eurozone that enjoyed a strong reduction of risk premiums on the side of financial markets. The inflow of external funds was a critical element of the growth spurt in those economies. The acceleration of economic growth enabled increases in nominal wages that went far above the rates of inflation and productivity and thus contributed to the increase of ULC. The massive capital inflows boosted domestic consumption, mainly in the non-tradeable sectors, that then triggered an appreciation of the real effective exchange rate of the periphery. It is this exchange rate effect that strongly undermined price competitiveness of the peripheral economies and contributed to the deficits in the current account. In other words, it was not fiscal profligacy on the side of national governments or the failure of national wage regimes to keep nominal wage increases in reasonable boundaries that eventually created tensions within the eurozone; the tensions were the outcome of massive cross-border capital flows. These tensions are best indicated by the divergent development of real effective exchange rates of member economies. The economies that eventually became crisis economies all experienced real appreciations of the exchange rates and thus a deterioration of the price competitiveness position. This outcome could have only been avoided by compensating wage policies that would have resulted in wage increases below the inflation rates. This policy approach was followed by Germany, which opted for a policy of wage restraint during this sequence that then led to an enormous improvement of its competitiveness position under conditions of weak economic growth and a low inflation rate. Even though the debt boom and bust cycles in the periphery of the eurozone were financially fed by surplus economies like Germany, they were not caused by the asymmetry of current accounts.7 The asymmetry was a consequence of the deepening of financial integration that came with the launch of the euro. In this sense, the institutional flaw of a disconnect between financial integration and regulatory banking integration was critical for the buildup of contradictions that provided the ground for a crisis trigger, unlike Sandbu, who argues that, “the excessive debt and credit buildups that have been at the heart of the eurozone’s near-death experience would have happened in much the same way without the euro” (2015, p. 11). I suggest that the events in sequence 1 already show distinct marks of the institutional architecture of the eurozone—the decision to liberalize financial markets in order to create a pan-European financial market and to simultaneously keep banking supervision on the national level created a situation of underregulation (Begg et al., 1991). Even though it is an uncontested fact that excessive private debts have also been built up in economies outside the eurozone, it can still be argued within reasonable margins that it was the creation of the euro that contributed to the drastic improvement of the creditworthiness of peripheral eurozone economies that then led financial markets to regard euro-denominated bonds of all member economies in the same way. In other words, the euro made differences in national risk premiums disappear and prepared the ground for credit booms even in economies that would probably not have qualified for the large inflow of capital. The result was the buildup of assets that eventually turned sour (Koo, 2015; Obstfeld, 2013).

The eurozone crisis is an endogenous event that only was waiting for a trigger. Paradoxically, the crisis was triggered by an event that actually falls outside the concept of crisis endogeneity: the announcement of the then Greek finance minister George Papaconstantino from the newly elected PASOK government in October 2009, who stated that the budget deficit would probably be double the previous government’s estimate and reach 12.5% of GDP. This statement not only kick-started a downgrading of Greece’s credit rating but also was the alarm for financial markets to take a closer look into the debt situation of eurozone member economies. How did a special crisis of fiscal profligacy and excessive public deficits quickly turn into a number of sovereign debt crises that threatened the survival of the overall eurozone? Sequence 2 is a textbook case of financial contagion and herd behavior of financial market actors that resulted in self-fulfilling prophecies (Nauhaus & Schäfer, 2015). After taking a second look onto eurozone member economies and the balance sheets of governments and banking institutions, financial market actors increased the risk premiums for credits, which resulted in a sudden stop of credit flows toward the group of current account deficit economies. In a brief period of time, the state of equalized risk-adjusted nominal interest rates made room for a strong scissor effect with steeply increasing rates for the southern periphery. The outcome was a wide-range liquidity crisis of the banking sectors in lender economies that threatened to develop into solvency crises. De Grauwe (2010) explained this particular chain of events with his fragility hypothesis, which simply states that member states of a currency union are potentially prone to sudden stops and self-fulfilling prophecies because they have issued debt in a currency they can’t control themselves. When market sentiments turn sour in regard to the ability to make proper debt service, financial markets become worried about the provision of sufficient liquidity. In the case of a debtor economy that issued debt in its own currency, there is always a central bank that is able, willing, and legally allowed to provide unlimited liquidity. This is not the case in a currency union, and it was definitely not the case for the eurozone during sequence 2. In their case studies of Spain and the United Kingdom, de Grauwe and Ji (2013) demonstrated that the type of currency regime counts when it comes to effective credit costs in times of financial turbulences. The stand-alone currency regimes benefit significantly from refinancing terms in comparison to members of a currency union. This holds even in cases when debt indicators and macroeconomic indicators in both types of economies are similar (Saka, Fuertes, & Kalotychou, 2014). Furthermore, it has been shown that only one downward revision of the credit rating of a debt-prone economy is sufficient for contagion effects to strengthen in a currency union (Missio & Watzka, 2011). If, as has been suggested by this type of research, the relatively better situation of stand-alone economies is all about the unlimited provision of liquidity, then sequence 2 of the eurozone crisis is mainly about the built-in failure of the ECB to act as a lender of last resort (Krugman, 2014). Due to the lack of this institutional feature, it would have been up to national fiscal policy to provide liquidity in order to secure a banking sector that suffers from the sell-off of bonds and the stop of net inflow of capital from abroad. However, national fiscal policy was restrained by the Stability and Growth Pact and thus obligated to a pro-cyclical policy stance. Market-induced processes of deleveraging started to become prominent, as did political efforts to develop a crisis emergency scheme that would be available to deal with emerging economic threats. At this point, though, it was the lack of a lender of last resort function by the ECB that contributed to the emergence of a series of national banking crises that threatened the sustainability of the eurozone as a zone of irrevocably fixed monetary regime.

As a consequence, the European Commission and the member states of the EU had to start activities to make up crisis management schemes on the go and thus to thoroughly reform the existing institutional and political architecture of the eurozone. The overarching principle in all these efforts was an exchange of financial support for political sovereignty regarding economic policy. The result of the sell-off of government bonds in the course of financial contagion was the dwindling liquidity and even solvency of national banks. National governments responded to this threat by providing liquidity that they received from the newly created emergency funds under the leadership of the EU. What started out as a debt crisis of private sectors, in particular the financial industries of some member economies of the eurozone, quickly transformed into a number of sovereign debt crises. It is this change in the nature of the eurozone that makes sequence 3 of the crisis processes so relevant. When institutional failures were at the heart of the crisis narrative in the first two sequences, the story in sequence 3 is about policy failure (Sandbu, 2015). Rather than dealing with the emerging crisis by a concise program of debt restructuring, the EU insisted on heavy-loaded fiscal austerity and structural reform programs under the joint control of the Commission, ECB, and the IMF.8 Even though the private balance sheet crisis transformed into a sovereign debt crisis, it is still astounding that the EU created a crisis management regime that, at a time of private deleveraging, insisted on harsh fiscal austerity9 and, consequently, on a policy that would contribute to the worsening of the public debt situation (De Grauwe & Ji, 2013). Rather than diverting the concerns of financial markets, the austerity regime and its implied “paradox of thrift” effects moved the eurozone ever closer to a self-fulling prophecy. Based on conservative assumptions, a calculation of the size of fiscal multipliers in the eurozone found that fiscal consolidation between 2011 and 2013 reduced GDP between 4.3% and 7.7% (Gechert, Hughes-Hallett, & Rannenberg, 2015). Instead of calming financial nervousness, the launch of bailout programs for Greece, Ireland, and Portugal, and then for Spain, actually contributed to an ever-increasing level of anxiety as the policy outcomes of austerity were showing worsening public debt indicators. In a functional view, one can argue that the negative effects of fiscal austerity created a “live-or-die” situation that was then partially overcome by the decision of the ECB in June 2012 “to do whatever it takes,” and thus to de facto add a lender of last resort function to the mandate of the ECB (de Andoain et al., 2015; Micossi, 2015). In political terms one can argue that this decision presented by Mario Draghi was the outcome of the strong economic pressure by financial market actors who successfully made the ECB save their bad credits by forcing a large bond purchase program on second markets. In any case, the transformation of the ECB to a “full-fledged” central bank gave the political actors significant breathing space for institutional reforms (Claeys, Leandro, & Mandra, 2015; Hübner, 2015).

One outcome of the actions of the ECB was the disappearance of the threat of an immediate dissolution of the eurozone. In political-economic terms the eurozone moved into much calmer waters, and this was reflected in the significant decrease of risk premiums across the eurozone and, thus, in a drastic reduction of contagion fears on the side of political actors. Even during the intense Greek crisis in 2015, the problem was not so much contagion or widespread economic fears about the survival of the eurozone, but rather the rise of severe political tensions within the eurozone as well as within member economies that were seen as questioning the shape of the common currency. In many countries, governing has become a more complicated affair as governments learned that the effects of deep financial crises were stubborn and difficult to overcome (Streeck, 2015; Streeck & Elsässer, 2016). The political concerns that characterize sequence 4 may not be solely related to the long-term effects of the eurozone crisis and its crisis management, i.e., the subdued level of economic growth in combination with high unemployment rates, low levels of inflation, and politically constrained public budgets but can be seen as part of the fallout of those processes. Whether this combination is best described as a European version of secular stagnation or a European variant of Japanese deflation is up to the observer. In analytical terms it does make good sense not to overstretch the term “crisis,” as each crisis by definition has a start point as well as an end point. However, it would be misleading to analyze sequence 4 simply as the end point of the eurozone crisis. In contrast to an increasingly strong view in the literature (see Jones, 2014), the sequential approach suggests interpreting sequence 4 as a post-crisis period that is characterized by unsolved intra-eurozone contradictions and a high level of political and economic uncertainty in member states.

The events of the eurozone crisis can be seen as a confirmation of a trilemma that was first suggested by Rodrik (2011) in regard to the processes of economic globalization: political democracy, sovereignty of the nation-state, and global economic integration are mutually incompatible. You can have any two of the three simultaneously but never all three in full. This trilemma can be applied to the eurozone situation. When the sudden stop of intra-eurozone capital flows occurred, the most exposed economies had to move under emergency umbrellas provided by the troika that explicitly restricted their political autonomy as liquidity was only provided in exchange of the acceptance of policy programs formulated by creditors. Moreover, the kind of conditionalities that became the core of assistance programs directed by the troika of European Commission, ECB, and IMF intervened directly into national democratic processes insofar as the range of available policy options were drastically reduced. In order to stay in the eurozone, member economies had to give in and to be willing to (at least temporarily) accept the partial transfer of policy sovereignty to the creditors: “while national governments and parliaments continue to be held responsible by citizens for their economic and social well-being, they have lost any meaningful ability to choose among alternative options. In all countries, they implement pretty much the same deeply unpopular, as well as ineffective, austerity package. Frustration and alienation are running high” (Armingeon & Baccaro, 2012, p. 275).

Unpopularity of policies does not automatically translate into political unrest or regime change. However, empirical illustrations across the eurozone and all over the EU indicate that the level of trust in the project of European integration in general and in the common currency in particular is diminishing (FES 2016). Rather than being an elusive phenomenon, the loss of trust in the common currency may become a lasting trend if the economies of the eurozone continue to stick on their low-growth paths. It is well established knowledge that financial crises, in contrast to business cycle crises, need relatively long periods to overcome and to compensate for the output losses occurred during the crises. It is a less accepted wisdom in the political arena that austerity policies in times of financial crises is not expansionary but, quite the opposite, moves economies onto a potentially deflationary path. In a situation of a balance sheet crisis, private actors across the board start to deleverage in order to clear their books and to reduce credit risks. If the public sectors are simultaneously being forced to reduce their debt exposures by turning toward fiscal austerity, the overall result is a dampening of economic growth and a further rise of public debt ratios, which may consequently lead to more fiscal consolidation.

Even though not all debt-loaded eurozone economies fell victim to this vicious circle,10 it seems reasonable to state that fiscal austerity made a critical contribution to moving the eurozone onto a long-term low-growth path (De Grauwe, 2016). It is tempting to analyze the economic situation of the eurozone in terms of the secular stagnation approach suggested by Summers (2015), who speaks of this type of secular stagnation when even extremely low or even negative real interest rates are no longer generating a full employment output level. In such a situation, savings are not financing productive investment but flow toward financial assets and contribute to the buildup of asset inflation. Whether and how the austerity regime of the eurozone has contributed to such an economic constellation is up to future research (see Fátas & Summers, 2015). Secular stagnation is not only a challenge for the fiscal policy regime of the eurozone but also for the ECB which, on the one hand, will have problems moving further into the negative nominal interest rate zone and, on the other hand, needs to avoid to further stimulate an asset inflation which may add to the financial fragility of the eurozone.

Under conditions of low economic growth, high unemployment, low inflation, high public debt ratios, significant private debt overhangs, as well as a restrictive supranational policy regime, one should not expect strong and decisive fiscal policies intended to move the eurozone back on its pre-crisis growth path. Rather, one can expect further cuts in public investments and—in the best case—an overall flat public sector contribution to economic growth (Crafts, 2015). Weak economic growth and a still fragile and vulnerable banking system across the eurozone is a potentially dangerous cocktail that may provide the ground for a next financial crisis. Despite all the changes in its economic governance regimes, it would be probably too optimistic to assume that the EU or the eurozone are well prepared for a next crisis. On the contrary, political preferences of member states seem only to allow for lowest denominator compromises that do not weatherproof the common currency. Political recipes to overcome the current snail-speed reform processes are ubiquitous and range from the proposal for a genuine banking union in combination with an adequate resolution mechanism, to eurozone-wide bonds in order to destroy the sovereign-banking loop, to the coordinated removal of public and private debt overhangs as an attempt to renationalize fiscal policy (Eichengreen & Wyplosz, 2015; O’Rourke & Taylor, 2013). Such proposals require fundamental changes in national policy preferences and the willingness as well as the ability to fundamentally move away from piecemeal political reforms toward a coherent eurozone-wide strategy. There is no good reason to expect this to happen. What can be expected, though, is a continuation of half-hearted reforms that are driven by national policy preferences. Whether this is sufficient to overcome the slow decay of European integration projects remains to be seen.

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## Notes:

(1.) It is worth emphasizing how Mundell felt about the missing political union-aspect of the new currency: “Political integration of the EU cannot be counted on in the near future. For that reason, the EU cannot be considered a strong central state. It will, therefore, have to rely on two other measures to make up for what would otherwise be a fatal weakness. The most important factor is the military alliance of NATO, a god bargain in buying confidence in the peace and security of Europe. Also important are the EU’s gold and foreign exchange reserves which will help provide confidence in the fallback value of the euro” (Mundell, 1998, p. 231).

(2.) It needs to be stressed against a dominating but misleading view of the eurozone crisis as a public debt crisis, that the “excessive debts” of the periphery were mainly debts of private actors, and that Greece was the exemption (Gibsons, Palivos, & Tavlas, 2014; Honkapohja, 2014).

(3.) The further statement that previously reported deficits of Greece were wrong and that deficits were actually much higher did not help calming down financial markets (Lane, 2012).

(4.) TFEU, article: 124: “The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project” (p. 125)

(5.) This misinterpretation is explained by Chang and Leblond with the argument that debt sustainability lies “in the eye of the beholder: as long as investors believed in the solidarity or integrity of the euro area, bond yields remained reasonable” (2015, p. 638). This sentiment is rightly described but not really explained: Why is it that market actors create and believe their own narratives?

(6.) It should be noted that even authors (e.g., Howarth & Quaglia, 2015) who seem to think differently do eventually prefer to speak of the “euro sovereign debt crisis”—a strange title (1) given that the euro is not representing a sovereign and (2) neglecting the fact that the eurozone crisis has not started as a number of sovereign debt crises. Dawson, Enderlein, and Joerges (2015) named a whole book Beyond the Crisis, and there are many more examples that indicate a tendency to see the crisis as overcome.

(7.) This is an important distinction. Johnston and Regan (2015), for example, make use of the varieties of capitalism approach and conclude that the idea to merge economies that follow two distinct growth models (export-led growth vs. internal demand–led growth) more or less automatically had to result in contradictions and crises as both growth models were fundamentally incompatible.

(8.) A prominent subtopic in the academic debate is the role of Germany in the design and makeup of austerity (Hübner, 2015) that led Vines (2015) to formulate a new impossible trinity where it is no longer possible to bring together the common currency, German policy preferences and a coherent macroeconomic analysis. With Nedergaard and Snaith (2015) and others, one can argue that the insistence on ordo-liberal principle resulted in unintended consequences that deranged the eurozone from its growth path.

(9.) Quite a lot of scholarship is dedicated to explain the focus on austerity with the institutional power of Germany (Steinberg & Vermeiren, 2015). The ordo-liberal narrative in German political life seems to be the preferred argument (Dullien & Guerot, 2012). Even though one should not underestimate the power of ideas, it may be a good idea to also look at the underlying national preferences of key political and economic actors. Ordo-liberalism may not be the only critical idea, as Helgadottir (2015) argues, as the “Bocconi boys” may have even been more instrumental in the placement of austerity in the Commission.

(10.) The best example of a successful deviation from the austerity recipe of the creditors is Ireland, where fiscal austerity as well as structural reform programs had only a marginal part in the economic recovery processes (Regan, 2016).