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A Fragile Eurozone in Search of a Better Governance

  • PAUL DE GRAUWE

    (University of Leuven)

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    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 member countries of a monetary union are downgraded to the status of emerging economies. This makes the monetary union fragile and vulnerable to changing market sentiments. It also makes it possible that self-fulfilling multiple equilibria arise. I analyse the implications of this fragility for the governance of the Eurozone. I conclude that the new governance structure (ESM) does not sufficiently recognise this fragility. Some of the features of the new financial assistance are likely to increase this fragility. In addition, it is also likely to rip member-countries of their ability to use the automatic stabilisers during a recession. This is surely a step backward in the long history of social progress in Europe. I suggest a different approach to deal with these problems.

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    File URL: http://www.esr.ie/vol43_1/01%20Grauwe.pdf
    File Function: First version,2012
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    Article provided by Economic and Social Studies in its journal Economic and Social Review.

    Volume (Year): 43 (2012)
    Issue (Month): 1 ()
    Pages: 1–30

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    Handle: RePEc:eso:journl:v:43:y:2012:i:1:p:1-30
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    1. 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.
    2. Winkler, Adalbert, 2011. "The joint production of confidence: lessons from nineteenth-century US commercial banks for twenty-first-century Euro area governments," Financial History Review, Cambridge University Press, vol. 18(03), pages 249-276, December.
    3. 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.
    4. Peirce, Fabrizia & Micossi, Stefano & Carmassi, Jacopo, 2011. "On the Tasks of the European Stability Mechanism," CEPS Papers 4262, Centre for European Policy Studies.
    5. 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.
    6. Kopf, Christian, 2011. "Restoring financial stability in the euro area," CEPS Papers 4292, Centre for European Policy Studies.
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