A Fragile Eurozone in Search of a Better Governance

36 Pages Posted: 27 May 2011  

Paul De Grauwe

London School of Economics & Political Science (LSE); CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Centre for Economic Policy Research (CEPR)

Date Written: May 2011

Abstract

When entering a monetary union, member-countries change the nature of their sovereign debt in a fundamental way (e.g., 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 analyze the implications of this fragility for the governance of the Eurozone. I conclude that the new governance structure (ESM) does not sufficiently recognize 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 stabilizers 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.

Keywords: Eurozone, multiple equilibria, governance

JEL Classification: E000

Suggested Citation

De Grauwe, Paul, A Fragile Eurozone in Search of a Better Governance (May 2011). CESifo Working Paper Series No. 3456. Available at SSRN: https://ssrn.com/abstract=1851324

Paul De Grauwe (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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