The Euro crisis and the new impossible trinity
AbstractThe search for solutions to the euro crisis is based on a partial diagnosis that overemphasises the lack of enforcement of existing fiscal rules. Europeâ??s leaders should rather address the euro areaâ??s inherent weaknesses revealed by the crisis.At the core of euro-area vulnerability is an impossible trinity of strict no-monetary financing, bank-sovereign interdependence and no co-responsibility for public debt. This Policy Contribution assesses the corresponding three options for reform: a broader European Central Bank (ECB) mandate, the building of a banking federation, and fiscal union with common bonds. None will be easy.The least feasible option is a change to the ECBâ??s mandate; changing market perceptions would require the ECB to credibly commit overwhelming forces, and the ECB is simply not in a position to make such a commitment.The building of a banking federation, meanwhile, involves reforms that are bound to be difficult. Incremental progress is likely, but a breakthrough less so.This leaves fiscal union. It faces major obstacles, but a decision to move in this direction would signal to the markets and ECB a commitment to stronger Economic and Monetary Union. One possibility would be to introduce a limited, experimental scheme through which trust could be rebuilt. This Policy Contribution draws on presentations made at the XXIV Moneda y CrÃ©dito Symposium, Madrid, 3 November 2011, at the Asia-Europe Economic Forum conference in Seoul, 9 December, and at De Nederlandsche Bank in Amsterdam on 17 December. I am very grateful to Silvia Merler for excellent research assistance. I thank participants in these seminars and Bruegel colleagues for comments and criticisms.
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Bibliographic InfoPaper provided by Bruegel in its series Policy Contributions with number 674.
Date of creation: Jan 2012
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-01-25 (All new papers)
- NEP-CBA-2012-01-25 (Central Banking)
- NEP-EEC-2012-01-25 (European Economics)
- NEP-IFN-2012-01-25 (International Finance)
- NEP-MON-2012-01-25 (Monetary Economics)
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