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Finance at Center Stage: Some Lessons of the Euro Crisis

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  • Maurice Obstfeld

Abstract

Because of recent economic crises, financial fragility has regained prominence in both the theory and practice of macroeconomic policy. Consistent with macroeconomic paradigms prevalent at the time, the original architecture of the euro zone assumed that safeguards against inflation and excessive government deficits would suffice to guarantee macroeconomic stability. Recent events, in both Europe and the industrial world at large, challenge this assumption. After reviewing the roots of the euro crisis in financial-market developments, this essay draws some conclusions for the reform of euro area institutions. The euro area is moving quickly to correct one flaw in the Maastricht treaty, the vesting of all financial supervisory functions with national authorities. However, the sheer size of bank balance sheets suggest that the euro area must also confront a financial/fiscal trilemma: countries in the euro zone can no longer enjoy all three of financial integration with other member states, financial stability, and fiscal independence, because the costs of banking rescues may now go beyond national fiscal capacities. Thus, plans to reform the euro zone architecture must combine centralized supervision with some centralized fiscal backstop to finance bank resolution in situations of insolvency.

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Bibliographic Info

Paper provided by Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission in its series European Economy - Economic Papers with number 493.

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Length: 55 pages
Date of creation: Apr 2013
Date of revision:
Handle: RePEc:euf:ecopap:0493

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Cited by:
  1. Pasimeni, Paolo, 2013. "An Optimum Currency Crisis," MPRA Paper 53506, University Library of Munich, Germany.
  2. Honkapohja, Seppo, 2013. "The euro crisis: a view from the North," Research Discussion Papers 12/2013, Bank of Finland.
  3. Reis, Ricardo, 2013. "The Portuguese Slump and Crash and the Euro Crisis," CEPR Discussion Papers 9591, C.E.P.R. Discussion Papers.

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