Correcting for the Eurozone Design Failures: The Role of the ECB

Abstract

Macroeconomic policies in the Eurozone have been dysfunctional since the eruption of the financial crisis. The failure of these policies to guide the Eurozone out of the crisis has everything to do with the design failures in the Eurozone. In this article, we first remind the reader of the nature of these design failures. We then analyze how these have led to ill-designed macroeconomic policies. We then focus on the role of the ECB on correcting for these design failures. We conclude with some thoughts about monetary and political unification.

Key Words:

• Eurozone
• sovereign debt
• fiscal union
• lender of last resort

Acknowledgements

The research reported in this article has been made possible by a grant of the Seventh Framework Programme ‘Finmap’. We are grateful for comments made by Marco Buti, Francisco Torres, Shanin Vallee, Frank Vandenbroucke and members of seminars given at the University of Leuven, and the University of Oxford.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. See Jones (2015) for a very complementary analysis.

2. Greece does not fit this diagnosis. It was clearly insolvent way before the crisis started, but this was hidden to the outside world by a fraudulent policy of the Greek government of hiding the true nature of the Greek economic situation (see De Grauwe 2011).

3. Attinasi, Checherita, and Nickel (2009), Arghyrou and Kontonikas (2010), Gerlach, Schulz, and Wolff (2010), Schularick, (2012), Caceres, Guzzo, and Segoviano (2010), Gibson, Hall, and Tavlas (2011), Aizenman and Hutchinson (2012), Beirne and Fratzscher (2012). There is of course a vast literature on the spreads in the government bond markets in general. See, for example, the classic Eichengreen and Mody (2000). Much of this literature has been influenced by the debt problems of emerging economies. See for example, Edwards (1984), Edwards (1986) and Min (1999).

4. We also experimented with the government deficit to GDP ratio. But this variable does not have a significant effect in any of the regressions we estimated.

5. Given the fact that the time dummies have reached negative territory in 2013, one may raise the question of whether the market has become too optimistic about the periphery, in a similar way as it was prior to the start of the crisis. During that period, the time dummies were negative suggesting that the according to the fundamentals the spreads of the periphery countries should have been higher. Optimism (euphoria), however, prevailed then and prevented the markets from seeing the risks. Our results suggest that the same may be happening since 2013.

6. See Giavazzi and Wyplosz (2015) for other aspects of the governance of the ECB.

7. This belief is well represented by De Mello and Padoan (2010) and European Central Bank (2015).

8. Begg et al. (2015) argue the case for structural reforms as a basis for sustainable growth.