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The political economy of the Euro crisis: Cognitive biases, faulty mental models, and time inconsistency

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  • Willett, Thomas D.
  • Srisorn, Nancy

Abstract

This paper discusses a number of major factors that led to the euro crisis and the failure of officials to deal with it effectively. It is argued that a good deal of these deficiencies in policy can be explained by a combination of faulty mental models, time-inconsistency problems, and cognitive biases such as wishful thinking. The project of European integration has brought great economic benefits and fulfilled the founders’ hopes that the European economies would become so tied together that war would be unthinkable. In creating the euro, however, they failed to recognize that monetary integration is fundamentally different from trade integration and that the group of euro countries as a whole did not come close to meeting the criteria for an optimum currency area. Furthermore the institutional infrastructure created for the euro was far too weak to head off emerging problems and to deal effectively with the crisis once it broke out.

Suggested Citation

  • Willett, Thomas D. & Srisorn, Nancy, 2014. "The political economy of the Euro crisis: Cognitive biases, faulty mental models, and time inconsistency," Journal of Economics and Business, Elsevier, vol. 76(C), pages 39-54.
  • Handle: RePEc:eee:jebusi:v:76:y:2014:i:c:p:39-54
    DOI: 10.1016/j.jeconbus.2013.12.001
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    References listed on IDEAS

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    1. Mark A. Pollack, 2001. "International Relations Theory and European Integration," Journal of Common Market Studies, Wiley Blackwell, vol. 39(2), pages 221-244, June.
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    5. Barth, James R. & Caprio, Gerard Jr. & Levine, Ross, 2012. "Guardians of Finance: Making Regulators Work for Us," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262017393, March.
    6. Graham Bird & Thomas D. Willett, 2008. "Why do Governments Delay Devaluation?," World Economics, World Economics, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 9(4), pages 55-74, October.
    7. Thomas D. Willett, 2012. "The role of defective mental models in generating the global financial crisis," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 4(1), pages 41-57, April.
    8. Andrews, David M. & Willett, Thomas D., 1997. "Financial Interdependence and the State: International Monetary Relations at Century's End," International Organization, Cambridge University Press, vol. 51(03), pages 479-511, June.
    9. Charles WYPLOSZ, 2006. "Deep Economic Integration: Is Europe a Blueprint?," Asian Economic Policy Review, Japan Center for Economic Research, vol. 1(2), pages 259-279, December.
    10. N/A, 2009. "Coordinated fiscal stimulus in the Euro Area," National Institute Economic Review, National Institute of Economic and Social Research, vol. 207(1), pages 27-38, January.
    11. Luc Eyraud & Anke Weber, 2013. "The Challenge of Debt Reduction during Fiscal Consolidation," IMF Working Papers 13/67, International Monetary Fund.
    12. Ulrich Volz, 2010. "Prospects for Monetary Cooperation and Integration in East Asia," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262013991, March.
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    Cited by:

    1. Levan Efremidze & John Rutledge & Thomas D. Willett, 2016. "Capital Flow Surges As Bubbles: Behavioral Finance And Mckinnon’S Over-Borrowing Syndrome Extended," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 61(02), pages 1-27, June.
    2. repec:eee:jebusi:v:94:y:2017:i:c:p:1-14 is not listed on IDEAS

    More about this item

    Keywords

    #60; F30; H12; Political economy; Eurozone; European union; Financial crisis; Debt crisis;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management

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