DP9521 How the Euro Crisis Evolved and How to Avoid Another: EMU, Fiscal Policy and Credit Ratings
|Author(s):||Vito Polito, Michael R. Wickens|
|Publication Date:||June 2013|
|Keyword(s):||credit ratings, EMU, euro crisis, fiscal policy|
|JEL(s):||E52, E62, H63, H68|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=9521|
This paper argues that the crisis was an outcome of EMU: setting a common monetary policy for countries with different initial inflation rates. The crisis countries were those with high inflation rates which then had negative real interest rates and consequently over-borrowed. Current policy discussions focus on crisis measures: fiscal, banking and political union, not avoiding another crisis. This paper suggests two ways to avoid a future crisis: offset an inappropriate monetary policy using fiscal policy; markets could better price loan rates by taking into account default risk. The paper shows that neither was done prior to the crisis.