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Hostages, Free Lunches and Institutional Gaps: The Case of the European Currency Union

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  • Günter Franke

    ()
    (Department of Economics, University of Konstanz, Germany)

Abstract

This paper argues that the strong member states of the European Currency Union are hostages of a financially distressed member state so that they are compelled to provide financial support. Moreover, due to the dynamics of the interaction game, a debt relief is a free lunch for the distressed country. This fosters moral hazard of distressed countries. In the absence of capital market control, European politics do not effectively monitor fiscal politics of member states. The lack of a long term strategy of the European Currency Union to deal with distressed states has undermined the credibility of politics. This lack is also explained by a lack of a European Insolvency Charter. A viable Union requires such a charter with rules for handling distress. Moreover, politics should determine a mechanism to coordinate politics and capital markets in their monitoring of fiscal and economic policy of member states.

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Bibliographic Info

Paper provided by Department of Economics, University of Konstanz in its series Working Paper Series of the Department of Economics, University of Konstanz with number 2011-47.

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Length: 26 pages
Date of creation: 20 Nov 2011
Date of revision:
Handle: RePEc:knz:dpteco:1147

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Keywords: European Currency Union; European Insolvency Charter; hostages; free lunch; externalization hypothesis;

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  1. Hans-Werner Sinn & Kai Carstensen, 2010. "Ein Krisenmechanismus für die Eurozone," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 63, pages 01-17, November.
  2. Carmen M. Reinhart & Kenneth S. Rogoff, 2010. "From Financial Crash to Debt Crisis," NBER Working Papers 15795, National Bureau of Economic Research, Inc.
  3. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  4. Sayantan Ghosal & Marcus Miller, 2003. "Co-ordination Failure, Moral Hazard and Sovereign Bankruptcy Procedures," Economic Journal, Royal Economic Society, vol. 113(487), pages 276-304, 04.
  5. Franke, Gunter, 1991. "Exchange rate volatility and international trading strategy," Journal of International Money and Finance, Elsevier, vol. 10(2), pages 292-307, June.
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