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Governance of a Fragile Eurozone

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  • De Grauwe, Paul
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    Abstract

    When entering a monetary union, member countries change the nature of their sovereign debt in a fundamental way, i.e. they cease to have control over the currency in which their debt is issued. As a result, financial markets can force these countries’ sovereigns into default. In this sense, the status of member countries of a monetary union is downgraded to that of an emerging economy. This makes the monetary union fragile and vulnerable to changing market sentiments. It also makes it possible that self-fulfilling multiple equilibria arise. This paper analyses the implications of this fragility for the governance of the eurozone. It concludes that the new governance structure (ESM) does not sufficiently recognize this fragility. Some of the features of the new financial assistance in fact are likely to increase this fragility. In addition, it is also likely to prevent member countries from using the automatic stabilizers during a recession. This is surely a step backward in the long history of social progress in Europe. The author suggests a different approach to deal with these problems.

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    File URL: http://www.ceps.eu/system/files/book/2011/05/WD%20346%20De%20Grauwe%20on%20Eurozone%20Governance.pdf
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    Bibliographic Info

    Paper provided by Centre for European Policy Studies in its series CEPS Papers with number 5523.

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    Length: 28 pages
    Date of creation: May 2011
    Date of revision:
    Handle: RePEc:eps:cepswp:5523

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    1. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
    2. Pierre-Olivier Gourinchas & Hélène Rey, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege," NBER Working Papers 11563, National Bureau of Economic Research, Inc.
    3. Bertrand Candelon & Amadou N. R. Sy & Rabah Arezki, 2011. "Sovereign Rating News and Financial Markets Spillovers," IMF Working Papers 11/68, International Monetary Fund.
    4. Kopf, Christian, 2011. "Restoring financial stability in the euro area," CEPS Papers 4292, Centre for European Policy Studies.
    5. Peirce, Fabrizia & Micossi, Stefano & Carmassi, Jacopo, 2011. "On the Tasks of the European Stability Mechanism," CEPS Papers 4262, Centre for European Policy Studies.
    6. Mayer, Thomas & Gros, Daniel, 2011. "Debt reduction without default?," CEPS Papers 4150, Centre for European Policy Studies.
    7. Alasdair Scott & Pau Rabanal & Prakash Kannan, 2009. "Macroeconomic Patterns and Monetary Policy in the Run-Up to Asset Price Busts," IMF Working Papers 09/252, International Monetary Fund.
    8. Rabah Arezki & Bertrand Candelon & Amadou Sy, 2011. "Sovereign Rating News and Financial Markets Spillovers: Evidence from the European Debt Crisis," CESifo Working Paper Series 3411, CESifo Group Munich.
    9. Jakob von Weizsäcker & Jacques Delpla, 2010. "The Blue Bond Proposal," Policy Briefs 403, Bruegel.
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