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How the euro crisis evolved and how to avoid another

OAI: oai:purehost.bath.ac.uk:publications/2fb61e9e-1ff8-4f8a-9fbf-bbc7d3507add DOI: https://doi.org/10.1016/j.jmacro.2013.09.004
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Abstract

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 - and 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.