Rebooting the Eurozone: Step 1 – Agreeing a Crisis Narrative

By Rebooting Consensus Authors. Originally published at VoxEU.

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The “Rebooting Consensus Authors” are:

Richard Baldwin, Thorsten Beck, Agnès Bénassy-Quéré, Olivier Blanchard, Giancarlo Corsetti, Paul de Grauwe, Wouter den Haan, Francesco Giavazzi, Daniel Gros, Sebnem Kalemli-Ozcan, Stefano Micossi, Elias Papaioannou, Paolo Pesenti, Christopher Pissarides, Guido Tabellini, and Beatrice Weder di Mauro.

This post seems like a little bit of a departure. First, I’ve never seen a named collective author at VoxEU before. Second, the effort seems to have some juice behind it. For example, somebody drew Krugman’s attention to the post. He writes:

Desperately Seeking Consensus

The good people at Vox EU are engaged in a laudable effort to clear the ground for euro reform, starting with the formulation of a “consensus narrative” about the origins of the euro crisis. This is a very good idea: How you think about the past plays a very large role in how you think about what should be done next.

Furthermore, their narrative looks very right to me. … It was a “sudden stop” crisis, in which vast capital flows into peripheral economies came to an abrupt halt, precipitating severe hardship largely thanks to the ; fiscal issues were a consequence, not a cause, of this financial harrowing.

But can they actually get the consensus they seek? It’s definitely worth trying. It’s obvious, however, that a lot of people inside and outside the eurozone have strong vested interests in other narratives. Will German officials stop insisting that it’s all about fiscal profligacy? Will Osborne & Co., or for that matter U.S. fiscal scolds, accept a narrative in which membership in the euro was a crucial element of the debacle, undermining their warnings that the UK or the US will turn into Greece, Greece I tell you unless we adopt austerity now now now?

I have my doubts, to say the least.

NC readers may find this material a bit mild. (As milk-and-water as “fiscal scolds,” perhaps.) That might not be the case in economics departments, treasuries, banks, and newsrooms where neoliberals roam the earth, bellowing and stamping, however. And now to the post:

* * *

The Eurozone needs fixing, but it is impossible to agree upon the steps to be taken without agreement on what went wrong. This column introduces a new CEPR Policy Insight that presents a consensus-narrative of the causes of the EZ Crisis. It was authored by a dozen leading economists from across the spectrum. The consensus narrative is supported by a long and growing list of economists.

The Eurozone Crisis broke out in May 2010; it is a long way from finished. Although some positive signs have emerged recently, EZ growth and unemployment are miserable and expected to remain miserable for years.

  • A large slice of Europe’s youth have been or will be jobless during the critical, formative years of their working lives;
  • The economic malaise is feeding extremist views and nationalistic tendencies just when Europe needs to pull together to deal with challenges ranging from the migration crush to possible new financial shocks.

Worse yet, many of the fragilities and imbalances that primed the monetary union for this crisis are still present.

  • Many of Europe’s banks face problems of non-performing loans;
  • Many are still heavily invested in their own nation’s public debt – a tie that means problems with banks threaten the solvency of the government and vice versa;
  • Borrowers across the Continent are vulnerable to the inevitable normalisation of interest rates that have been near-zero for years.

As a first step to finding a broad consensus on what needs to be done to fix the Eurozone, we have written what we consider to be a consensus narrative of the Eurozone Crisis. It is published today as CEPR Policy Insight 85, which can be downloaded for free from:

Rebooting the Eurozone: Step 1 – agreeing a crisis narrative

Although the authors hark from diverse backgrounds, we found it surprisingly easy to agree upon a narrative and a list of the main causes of the EZ Crisis. We say “surprisingly” since EZ policymakers remain attached to very diverse narratives of the Eurozone crisis.

The Need for a Consensus Narrative

Formulating a consensus on the causes of the EZ Crisis is essential. When terrible things happen, the natural tendency is to fix the immediate damage and take steps to avoid similar problems in the future. It is impossible to agree upon the steps to be taken without agreement on what went wrong. Absent such agreement, half-measures and messy compromises are the typical outcome. But this will not be good enough to put the EZ Crisis behind us and restore growth.

This is why formulating a consensus narrative of the EZ Crisis matters so much. Eurozone decision-makers will never agree upon the changes needed to prevent future crises unless they agree upon the basic facts that explain how the Crisis got so bad and lasted so long.

The EZ Crisis Was a ‘Sudden Stop’ Crisis

The core reality behind virtually every crisis is the rapid unwinding of economic imbalances. In the case of the EZ crisis, the imbalances were extremely unoriginal – too much public and private debt borrowed from abroad. From the euro’s launch till the Crisis, there were big capital flows from EZ core nations like Germany, France, and the Netherland to EZ periphery nations like Ireland, Portugal, Spain and Greece.

Importantly, the EZ Crisis should not be thought of as a government debt crisis in its origin – even though it evolved into one.

  • Apart from Greece, the nations that ended up with bailouts were not those with the highest debt-to-GDP ratios.
  • Belgium and Italy sailed into the Crisis with public debts of about 100% of GDP and yet did not end up with Troika programmes;
  • Ireland and Spain, with ratios under 40%, needed bailouts.

The real culprits were the large intra-EZ capital flows that emerged in the decade before the Crisis.

These imbalances baked problems into the EZ ‘cake’ that would explode in the 2010s. All the nations stricken by the Crisis were running current account deficits. None of those running current account surpluses were hit.

When the EZ crisis started, there was a ‘sudden stop’ in cross-border lending. Investors became reluctant to lend – especially to banks and governments in other nations. The special features of a monetary union meant that the ‘sudden stop’ was not precipitous (as it was, for example, in Iceland).

Rather this ‘sudden stop with monetary-union characteristics’ showed up in rising risk premiums. The abrupt end of capital flows raised concerns about the viability of banks and governments in nations dependent on foreign lending, i.e. those running current account deficits. Slowing growth produced big deficits and rapidly increasing public debt ratios. When things got bad enough, several governments had to take on some of their banks’ debt, thus increasing national debt ratios even further. This is how a balance of payments crisis became a public debt crisis.

Why EZ Membership Mattered: Crisis Amplifiers

Monetary union mattered since it allowed the cross-border imbalances to get so large with such little notice before the Crisis struck. It also mattered since the incomplete institutional infrastructure amplified the initial loss of trust in the deficit nations in several ways.

  • EZ governments who got into trouble had no lender of last resort.

Absent a lender of last resort, a small sustainability shock could be amplified without bound due to the deadly helix of rising risk premiums and deteriorating budget deficits stemming from higher debt servicing costs. This debt-default-risk vortex caught Portugal and came close to catching Italy, Spain and Belgium. Even France and Austria floated into the penumbra of debt vortexes at the height of the Crisis.

  • The other classic crisis response – devaluation – was impossible for euro-using nations. W1

Taken together, these two features meant their euro-denominated borrowing was akin to foreign currency debt in a traditional, developing nation ‘sudden stop’ crisis.

  • The close links between EZ banks and national governments greatly amplified and spread the Crisis.

This is the so-called ‘doom loop’ – the potential for a vicious feedback cycle between banks and their government. It was one of the key reasons that a single surprise in Greece could swell into a systemic crisis of historic proportions.

  • The predominance of bank financing transmitted bank problems to the wider economy.

As the ‘doom loop’ and slowing economy raised uncertainty, investment suffered much more than in countries where bank financing is less central, such as the US. This weakened economies in ways that worsened the sustainability outlook for nations and banks.

  • The rigidity of factor and product markets made the process of restoring competitiveness slow and painful in terms of lost output.

The whole situation was made much worse by poor crisis management. Mistakes were made, but above all there was nothing in the EZ institutional infrastructure to deal with a crisis on this scale. EZ leaders faced the dual challenge of fire-fighting and institution-building – all in a situation where the interests of debtors and creditors diverged sharply and European electorates were closely following developments.

Judging from market reactions, each policy intervention ‘saved the day’ but made things worse from the next day on. The corner was only turned in the summer of 2012 with the decision to set up a banking union and the “whatever it takes” assertion by ECB President Mario Draghi.

The following leading economists have agreed to support the consensus-narrative. If you are an economist and would like to support the consensus-narrative this, please email stating your support and attaching a CV showing you are an economist (business, media, academics, think tanks, etc.).

Supporters of the Consensus Narrative on the Eurozone Crisis (in order of replying)

Silvana Tenreyro, LSE, Sir Charles Bean, LSE (Ex-Deputy Governor Bank of England), Philippe Bacchetta, University of Lausanne, Jorge Braga de Macedo, Universidade Nova de Lisboa, Lars E O Svensson, Stockholm Univeristy (ex-Deputy Governor of Sveriges Riksbank), Andrew Rose, UC Berkeley, László Halpern, Hungarian Academy of Sciences, Refet S. Gürkaynak, Bilkent University, Giorgio E Primiceri, Northwestern University, Peter Bofinger, Universität Wurzburg, Jürgen von Hagen, Universität Bonn, Tryphon Kollintzas, Athens University of Economics and Business, Patrick Honohan, Trinity College Dublin (Ex-Governor of Central Bank of Ireland), Charles A Goodhart, LSE, David Vines, University of Oxford, Fabrizio Coricelli, University of Paris I, Stephanie Schmitt-Grohé, Columbia University, Pierre-Olivier Gourinchas, UC Berkeley, Evi Pappa, EUI, Cédric Tille, The Graduate Institute, Geneva (Member of the Swiss National Bank Council), Stephen G. Cecchetti, Brandeis International Business School (ex chief economic adviser for Bank of International Settlements), Carmen Reinhart, Harvard, Ugo Panizza, Graduate Institute, Geneva, Tommaso Monacelli, Bocconi, Donato Masciandaro, University of Bocconi, Tony Yates, University of Birmingham, Yannis M. Ioannides, Tufts University.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. D. Battabong

    My attention was drawn to the article’s lead-in: “authored by a dozen leading economists from across the spectrum”, so I went no further. Experience tells me there’s somewhere between a one in a dozen to zero percent chance of finding meaning. And, yes, this is a problem. Ignoring economists (who are always wrong) and politicians (who are never right), leaves a huge leadership gap.

  2. Chauncey Gardiner

    Thanks for posting an article about this initiative, Lambert.

    Re: …”It’s obvious, however, that a lot of people inside and outside the eurozone have strong vested interests in other narratives. Will German officials stop insisting that it’s all about fiscal profligacy? Will Osborne & Co., or for that matter U.S. fiscal scolds, accept a narrative in which membership in the euro was a crucial element of the debacle, undermining their warnings that the UK or the US will turn into Greece, Greece I tell you unless we adopt austerity now now now?”

    Building policy and structural consensus in the EU is clearly a huge challenge given the ideological, economic and geopolitical headwinds. I agree that the effort represented here is a necessary and constructive step.

    As a small aside, it is interesting to see Carmen Reinhart’s views apparently evolving.

  3. Jesper

    About this:

    EZ governments who got into trouble had no lender of last resort.

    Does any country with a current account deficit have a lender of last resort if/when the fiscal situation of the government is deemed unsustainable?

    1. Benedict@Large

      Deemed unsustainable? By whom? The EZ has created a currency with a set of rules that gives rise on occasion to sustainability issues. The solution is to fix those rules instead of blindly trying to enforce them regardless of the consequences. The real problem is that those who enforce those rules are never the ones who have to suffer the consequences

      1. Jesper

        Deemed unsustainable by me, after my decision then nobody else in the world dared to lend….
        Or was your question serious? Then maybe the answer is that you did? Or would you lend your dollars and/or euros to a nation in the state of Greece? At what rate would you lend to Greece?

  4. jfleni

    As an American, I say fix Failed-State-USA first and foremost!

    Euro-types can copy the example or do their own thing, whatever they want!

  5. Steven

    There is no reference to the The Global Minotaur problem (i.e. the loss of the ability of the US to continue financing Eurozone imbalances) following the 2008 financial crisis. Whatever one might think of Varoufakis, his analysis seems pretty convincing. This one on the contrary seems to be a very careful political analysis in which fundamental causes like unpayable debts, a flawed international monetary system and large and growing imbalances in the global are either not addressed or mentioned so obliquely it is impossible for lay readers like myself to recognize their inclusion in this ‘consensus’.

    It is way past time for the West (and the world) to start addressing core issues like:

    whether the world needs a new Global Minotaur (reserve currency) or a return to an honest system of ‘keeping score’ like the old “barbaric” gold standard so nations revert to the relatively more peaceful forms of competition prevalent in the 19th century (minus the imperialism);
    a realistic, equitable division of labor in the global economy – one under which smaller nations pay their way without piling up yet more unpayable debt to the world’s 1% and larger nations, without exporting yet more financial ‘toxic waste’.

    It is way past time for a reformed system of economics – or, as Michael Hudson would argue, a return to the principles of classical economics so laboriously developed over the centuries before they were abandoned for the “junk economics” imposed by the bankers and financiers on the consciousness of the so-called industrial democracies.

    Above all, on a finite planet “…a logical definition of wealth is absolutely needed for the basis of economics if it is to be a science.” – one that doesn’t violate basic laws of science (the perpetual motion machine myth of money as wealth forever creating more money as wealth out of nothing but book-keeping entries) or mathematics (i.e. “the miracle of compound interest”) For a start on that definition see CHAPTER VI, THE TWO CATEGORIES OF WEALTH: THE NATURE AND DEFINITION OF ABSOLUTE WEALTH in Frederick Soddy’s Wealth, Virtual Wealth and Debt, 2nd edition

  6. Ron Peters

    What went missing from the Krugman quote here? “…precipitating severe hardship largely thanks to the ; fiscal issues were a consequence, not a cause, of this financial harrowing.”

  7. JEHR

    From the original PDF, this caught my eye:

    “The ‘doom loop’ is a loop since it reaches back to the governments. Banks view their national government as their lender of last resort. But banks are also major lenders to the governments (via bond purchases). The rescue, in essence, would require the rescuers to borrow from the rescued.”

    Now wouldn’t you think that financial people would be able to see the ridiculousness of this kind of borrowing/lending?

  8. RMO

    I have to admit that when things went all pear shaped in the Eurozone I was surprised. This is because I paid no real attention to the details of how the single currency was implemented. Until it all started hitting the fan I was under the assumption that when they went to a single currency they had done so in a manner similar to the single currency in a large nation such as the U.S. or Canada – a central bank with considerable power and the provision of mechanisms to transfer money between areas. I never though they would have done the equivalent of getting rid of a city’s fire department in favor of a strategy that relies on the fact that every fire eventually burns out and that it occasionally rains.

  9. susan the other

    The global Minotaur was a financial whirlpool that perpetuated itself on credit. Some nations had a surplus – and they were spared the worst austerity – and some nations ran a deficit and they were hit with tightening. But in all countries the GFC hit suddenly. Credit shut down. It is a classic pattern – very Minsky if it weren’t for the biggest culprit – war. In 1929 the crisis came as a result of the debt of WW1 with too much deregulatlion in the 20s to pay back the war debt; and then the surpluses brought “growth” to a screeching halt which was only overcome by vast new war expenditures. In 2008 the war had been going on since 2003 and the debt was coming due. Similar to Vietnam when we rolled the debt over until 1973 and then faced a severe recession. I see a clearer pattern: credit and growth are stopped short (“suddenly”) when the military uses up all the money. It can only be hidden for a few years under accounting practices that require strong currencies. So when crises hit suddenly it is because banksters refuse to deal in other currencies’ debt. Seems like there is one choice: you can have capitalism or you can have war, but you can’t have both. Not even LBJ could.

    1. Steven

      As I understand it the Global Minotaur problem involves more than just “the effect of lending by foreigners vs lending to foreigners” with nations running chronic trade surpluses suddenly unwilling to lend to those running chronic deficits. What was broken by the 2008 financial crisis was the mechanism for recirculating the excess funds being accumulated by nations like Germany with chronic trade surpluses in their commerce with Greece and other smaller economies. The role of Goldman Sachs in helping Greece (and others?) hide its growing indebtedness has been well publicized. What went south in 2008 was inability of the global financial system to keep hidden any longer the fundamental insolvency of a recirculating mechanism based on the US dollar.

      While I certainly agree that the world has better uses for its wealth than funding global US military hegemony, I don’t think that was what really broke the system. Michael Hudson lists a number of contributing factors including the political ambitions of Dominique Strauss-Kahn and corrupt national elites preferring austerity for their subjects so they could continue substituting sovereign debt for taxation on their exponentially increasing monetary fortunes.

      Somewhere in there you have to fault Germany for not being willing to step up to the plate and subject itself to the Triffin dilemma. I don’t know whether the recirculating mechanism Varoufakis proposed would have worked or not. But Germany seems to have been unwilling to give it or something like it a try. It has instead adopted a “They borrowed the money, didn’t they?” policy which served Germany and the world oh so well in the last century.

  10. colm mccarthy

    I have one quibble – the Eurozone is described in the piece, using its self-description, as a ‘monetary union’. It is not a monetary union in the sense of the USA: it is just a common currency area. The distinction is at the heart of the design flaws which led to the crisis and frustrated its resolution.

    The relentless employment by the system’s defenders of the description ‘monetary union’ is a denial of responsibility for these design flaws, an attempt to off-load responsibility from the designers to the less fortunate participants and a justification of sloth in re-engineering the system.

    1. RBHoughton

      Not sure if I can go far with your quibble. What Herr Schauble told Portugal recently was ‘elections are one thing but there are rules’ meaning that whatever national government is elected to office, the EU treaty and subsidiary agreements are above and beyond its reach.

      That sounds like monetary union to me but perhaps the gentleman overstepped himself?

  11. Keith

    The Euro was a plan to reduce the power of democracy:

    “Let me issue and control a nation’s money and I care not who writes the laws.” Mayer Amschel Rothschild (1744-1812), founder of the House of Rothschild.

    “The putative “father of the Euro”, economist Robert Mundell is reported to have explained to one of his university of Chicago students, Greg Palast: “the Euro is the easy way in which Congresses and Parliaments can be stripped of all power over monetary and fiscal policy. Bothersome democracy is removed from the economic system”

    “Killing the Host” by Michael Hudson

    1. RBHoughton

      Completely agree. It is my suspicion that continentals still honour Napoleon and his attempt to bring an end to European war and substitute trade.

      They were particularly aware of the potential benefits after WWII whilst the Anglosphere was far less touched by damaged infrastructure.

      1. Synoia

        The anglosphere was far less touched?

        On what planet was the UK “less touched” physically and economically?

        1. Robert Dudek

          Compare the way Warsaw and London looked at the end of 1945 and you should begin to get a feel for the difference.

  12. Peter Dorman

    Since Mark Thoma (for reasons beyond his control) had to stop linking to a wider set of blog posts, a lot has disappeared from people’s screens. That includes this post, which I wrote in response to the EU Vox letter. In short, there’s a self-destruct bomb inserted toward the end of the “consensus narrative” that undoes everything the document says it’s trying to do.

  13. Gee

    I found this to be a bit of a glossing over of things :

    “several governments had to take on some of their banks’ debt,…”

    It wasn’t nearly so simple, especially in Ireland. That the national government took on the banks bad debts was a policy choice somewhat forced upon Ireland. And a huge turning point in deciding how this problem would mutate and perpetuate.

  14. washunate

    It’s fascinating reading this a couple days later.

    a consensus-narrative of the causes of the EZ Crisis

    How can we agree on a narrative when words like fraud and NATO aren’t even used?

Comments are closed.