The New Eurozone Risk Morphology

Abstract

Ten years into the global financial crisis, the euro area is struggling to get back on a path of stability and growth. Leaving aside international factors, many underlying reasons come from within and range from the EMU architectural incompleteness to the reluctance to address some key issues, starting from the ECB mandate and constraints. These reasons develop along two main risk backbones that define the Eurozone risk morphology: large and persistent competitive gaps, which contrast center and periphery, and systematic risk segregation, which hinders effective progress towards a fiscal union. The present paper explores these two risk backbones and measures them through economic and financial indicators that are closely related to each other. The critical values of these indicators highlight a matter of unsustainability of the EMU membership, as hinted by the rising Euro-skeptic debate. This has resulted in a confrontational attitude of most distressed countries with the European institutions, which in turn has been translated into higher sovereign risk premia as in the recent Italian experience. The recipe for these problems cannot be limited to a strengthened surveillance and stricter stability discipline of the financial sector: it must open to risk sharing in order to definitively defuse centrifugal forces, remove financial and commercial imbalances, and pave the way for a fiscal union with a federal budget, an unified debt market and a single finance minister.

Keywords: Competitive Gaps, Financial Real Effective Exchange Rate, Inflation Differentials, Real Sovereign Yield Spreads, Target2, Risk Segregation, Risk Sharing

JEL Classification: E02, E58, G01, H12, H63