Europe's Crisis, Europe's Future

1. Europe's Crisis, Europe's Future: An Overview

1 The economic crisis that started in Greece in late 2009 quickly spread to Ireland and Portugal and then to Spain and Italy. After becoming a major eurozone crisis, it eventually came to threaten the global system in the autumn of 2011. And like the subprime crisis in 2008, no one had predicted it. There had been, of course, many warnings in the 1990s, before the euro was launched, about forming a monetary union without a sufficient political union. But the first ten years of the euro seemed quite successful. The warnings and criticisms died down quickly. Interest rates inside the eurozone converged surprisingly rapidly, as if membership in this monetary union was a sufficient condition for an immediate equalization of sovereign creditworthiness; credit conditions became so favorable that growth in the periphery countries where there were more “catch-up” opportunities—those that would shortly become the crisis countries—was particularly strong; Spain, for example, was not far from being called a new economic miracle. As late as December 2008, The Economist published a spectacular assessment of what had been achieved, calling the “euro at ten” a “resounding success” and confirming to its readers the belief that the single currency had proved “demonstrably durable.” The evolution of the euro-dollar exchange rate was a visible confirmation of these comments . Initially fixed at 1.19 dollars in 1999, the value of the euro declined during its two first years when “irrational exuberance” in the United States was fueled by the promise of the new information technology (IT) economy. But Europe’s Crisis, Europe’s Future: An Overview kemal derviş and jacques mistral 1 2 kemal derviş and jacques mistral after the dot-com bubble burst, the value of the euro rose more or less steadily and exceeded 1.55 dollars in the spring of 2008. We do not recount the details of the causes and the evolution of the eurozone crisis in this overview. The individual chapters in this volume describe the onset and evolution of the crisis in Greece, Italy, and Spain, as well as its effects in France and Germany; supporting comparative macroeconomic data are also available in the appendix. A chapter on the financial sector and one on social policies focus on two areas of particular importance for the eurozone. A few words regarding the systemic aspects of the crisis at the eurozone level are nonetheless appropriate in this introduction. The global economic prosperity during the first ten years of the euro helped conceal a deeply rooted vulnerability that was fully exposed once the economic crisis set in. The global crisis that began in 2008 was not the cause of the eurozone’s economic woes, but it was a tipping point for economies that had been operating on unsound foundations for a while. The monetary union and the way it had been managed had allowed a large build-up of public and/or private debt in many countries and a serious divergence of real unit labor costs, and therefore a loss of competitiveness. Regarding its public debt component, the crisis would have been much more manageable if the Maastricht Treaty, with its limits on public debt and deficits, had been fully enforced. Germany and France had been the first to violate the treaty, damaging the sense of discipline that was so essential to a proper functioning of the monetary union, and thereby set a bad precedent for others. It is also true, however, that the crisis in Ireland and Spain—countries that did not violate the Maastricht criteria—was not of a fiscal nature. It was due in both cases to a real estate bubble allowed by excessive increases in private debt—leading to a terrible banking crisis. The dangers of excessive growth in private or public debt, despite being clearly reflected in large current account deficits, were not addressed in a timely way, as they would have been under the weight of the “external constraint ” before the introduction of the single currency. Initially, the response to increasing levels of public debt was benign neglect. With regard to private debt, neither market players nor the eurozone’s leadership imagined that private investors and financial institutions could make such huge mistakes. This blind belief in the infallibility of markets was similar to what had led to the subprime mortgage debacle that triggered the financial crisis in the United States. The currency union and the Maastricht Treaty alone did not have strong enough enforcement mechanisms to ensure adequate banking and...