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New eBook: Completing the Eurozone rescue: What more needs to be done?

The euro’s crisis is not over. Measures taken in May were critical but they were palliatives not a cure. The Eurozone rescue needs to be completed. This column introduces a new Vox eBook that gathers the thinking of a dozen leading economists on what more needs to be done.

Eurozone leaders embraced two bold moves in May – a Greek bailout worth €110 billion, and a Special Purpose Vehicle to fund future bailouts up to €750 billion (counting the IMF’s maximum contribution)--enough to refinance Irish, Portuguese, and Spanish public debt needs for a couple of years. And the ECB is helping with direct purchases of government bonds.

Isn’t this enough?

We invited a dozen world-renowned economists to answer the simple question: What more needs to be done? The eBook posted today – “Completing the Eurozone rescue: What more needs to be done?” – presents their answers.

Although the essays were largely uncoordinated – and the authors hark from diverse backgrounds – a remarkably coherent message emerges. The authors unanimously believe that the crisis is not over, and that the Eurozone rescue is not finished. More needs to be done.

As Charles Wyplosz puts it, the Eurozone is levitating on the hope that European leaders will find a way to end the crisis and take steps to avoid future ones. Unless more is done, however, this levitation magic will wear off and the Eurozone crisis will resume its destructive, unpredictable path.

The crisis, in our view, is a thorny tangle of incipient debt and banking crises. Until this tangle is sorted out, any further shock could threaten the Eurozone as we know it. After all, Eurozone bank systems remain in a parlous state. Confidence in the financial system has not been restored. The losses from the Spanish real estate binge have only partially emerged. Greek public finances have still not been stabilised. Large competitiveness imbalances persist.

In short, none of the underlying causes of the crisis have been addressed.

Massive shocks could come from any number of sources ranging from the Spanish banking sector to political crisis in member countries facing fiscal austerity. Indeed, we already see ominous signs. Risk premiums on some Eurozone government debt have resumed their upwards trend despite the two May packages.

We also know that even small shocks can lead to a major crisis given the interconnected fragility of the Eurozone. Remember that it started with fiscal problems in a country which accounts for only 2.5 % of Eurozone GDP. Banking crises in a number of European countries could cause sovereign debt crises – a la Reinhart and Rogoff (2009) – which could spark contagion, thus triggering more bank crises. Trying to muddle through would be like sleepwalking through a minefield.

The time for action is now, for, as Barry Eichengreen puts it, “financial crises feed on uncertainty. The longer uncertainty is allowed to linger, the greater the damage to confidence…”.

Interconnected causes of the crisis

The Eurozone’s policy framework was designed like the rigging of a racing sailboat whose interlocking system of stays and braces could hold against the strongest winds – but only as long as all parts hold. Failure of one or two cables transfers overwhelming stress to other parts, potentially triggering a catastrophic collapse of the entire rigging.

This is what happened in the 2010 Eurozone crisis and its run-up. In fact, many of the “cables” in the Eurozone’s policy-framework proved deficient and the Eurozone sailed into the storms of Spring 2010 with three of its mainstays broken.

Broken cable #1: The failure of deficit discipline meant that almost half the Eurozone nations, and all of the largest ones, entered the crisis period (2007 – 2010) with high debt ratios – many well above the Maastricht limit. Greece and Italy had debt ratios that markets might think were perilously close to the unsustainability precipice.

Broken cable #2: The lack of competiveness policies (or sufficiently countercyclical national fiscal policy) fostered large current account imbalances. These current accounts were financed mainly by banks in the Eurozone core nations. As a result, any debt crisis in the periphery threatened a banking crisis in the core.

Broken cable #3: Eurozone banks, including those in the Eurozone core, were dangerously overleveraged due to regulatory failures before 2007 and half-hearted bank clean-ups in 2008 and 2009.

All that was needed was for the wind to blow from the wrong direction – a wind from the southeast, as history would have it.

Lesson from the causes of the crisis

One ugly word describes this crisis – interconnectedness. Government debt and bank crises were interconnected, as were policy failures. No single element of the Eurozone’s policy framework can be pointed to as “the” culprit. The systemic nature of policy failures and risks facing the Eurozone demands a systemic solution.

“Limiting reform ambitions to tinkering with the Stability and Growth Pact would be widely regarded as indicative of a worrying inability to reform,” writes Jean Pisani-Ferry. As Barry Eichengreen – who predicted this crisis in January 2009 (Eichengreen 2009) – writes: “To avoid similar crises in the future, Europe will have to build out the institutions of its monetary union.”

The authors almost unanimously eschew solutions based on radical transfers of sovereignty to the EU. As Paul De Grauwe puts it: “… full political union seems unrealistic for the foreseeable future.” What is needed is a lot more national discipline and a bit more European discipline to coordinate it.

Banking and financial market regulation

While Europe’s banks remain a mess, every shock has the potential to create a systemic crisis. The first important step to cleaning up the banks is improved transparency. Stress tests of Eurozone banks need to be released in order to reveal the potential losses that are now lurking in the darkness, causing banks to doubt each others’ solvency. This would clear the road for bank recapitalisations where needed. Dealing with the weak bank-problem now will be cheaper than continuing with blanket guarantees. And financial sector resolution frameworks need to be improved at a European level to deal with cross-border bank failures.

Many authors in this eBook call for an explicit European Debt Resolution mechanism that would allow nations like Greece to restructure its debt; the essay by Avinash Persaud presents some clear thinking on this. Thomas Mayer argues that such a mechanism would put an end to what he calls bailout “blackmail”.

Fixing fiscal policy

Charles Wyplosz voices the views of many authors when he writes: “…fiscal discipline is and remains a deeply seated national prerogative of each national government and parliament. The inescapable implication is that the Stability Pact must be decentralised to where authority lies. … Each country must be required to adopt national institutions that can guarantee fiscal discipline.” Many authors suggest Eurozone members be required to set up domestic “Independent Fiscal Councils”.

Locking in commitments to medium-term discipline while allowing the flexibility for short-term national stabilisation, will not be easy. The essays by Philip Lane, and by Antonio Fatas and Ilian Mihov contain important insights on how “independent fiscal councils” should operate. Michael Burda and Stefan Gerlach offer some novel thinking on how to coordinate the new national institutions.

Monetary policy

The ECB’s “securities market programme” is an emergency reaction to an emergency situation. EU leaders must stress that they will not rely forever on the ECB buying the debt of countries investors no longer trust. The programme creates balance-sheet risks for the ECB, and complicates the conduct of monetary policy. Implementing concrete measures which convince markets that the crisis’s causes are being remedied should allow the ECB to stop its purchases without markets overreacting.


To avoid future imbalances, Eurozone nations should use counter-cyclical fiscal and regulatory policy to dampen developments in national wages, assets, and prices that might undermine competitiveness. However, fiscal policy cannot ensure adjustment alone. To repair macroeconomic imbalances in the GIPS (Greece, Ireland, Portugal, and Spain) wage adjustments are needed; here labour market reforms will help.

Pro-growth structural policies are a critical part of the reform. Structural reforms, especially in the services sector, would enhance growth easing labour market adjustments while bolstering debt sustainability ratios. As Alberto Alesina and Roberto Perotti argue: “The constraint on European growth is not Germany’s fiscal policy. It is the supply-side rigidities that riddle all European national economies – especially those of southern European countries.”


The Eurozone ‘ship’ is holed below the waterline. The ECB actions are keeping it afloat for now, but this is accomplished by something akin to bailing the water as fast as it leaks in. European leaders must very soon find a way to fix the hole.

It is time to put national differences aside and finish the job of restoring stability and prosperity in Europe. While the European flotilla may have run aground, it need not sink. But rescuing the Eurozone will require coordination, teamwork, and discipline.

Acknowledgements: We thank Cinzia Alcidi, Bob Denham, Jonathan Dingel, Sam Reid, Anil Shamdasani, and Pierre-Louis Vézina for outstanding assistance; Luc Laeven edited several papers and contributed importantly to the introduction.

Other References

Eichengreen, Barry (2009), “Was the euro a mistake?”, VoxEU.org, 20 January.

Reinhart, Carmen and Kenneth Rogoff (2009), This Time is Different: Eight Centuries of Financial Folly, Princeton University Press.

The eBook’s Table of Contents

Completing the Eurozone rescue: What more needs to be done?
Edited by Richard Baldwin and Daniel Gros

Introduction: The euro in crisis – What to do?
Richard Baldwin and Daniel Gros

Drawing a line under Europe’s crisis
Barry Eichengreen

The Eurozone needs a political union, or at least elements of one
Paul De Grauwe

The Eurozone's levitation
Charles Wyplosz

Eurozone governance: What went wrong and how to repair it
Jean Pisani-Ferry

The European bicycle must accelerate
Angel Ubide

What more do European governments need to do to save the Eurozone in the medium run?
Thomas Mayer

The narrative outside of Europe about Europe’s fiscal crisis is wrong
Avinash D. Persaud

Rethinking national fiscal policies in Europe
Philip R Lane

A credible Stability and Growth Pact: Raising the bar for budgetary transparency
Michael C. Burda and Stefan Gerlach

Fiscal policy at a crossroads: The need for constrained discretion
Antonio Fatás and Ilian Mihov

Fiscal consolidation as a policy strategy to exit the global crisis
Giancarlo Corsetti

German spending is not the cure
Alberto Alesina and Roberto Perotti

The long shadow of the fall of the wall
Daniel Gros

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