Causes of the Eurozone Crisis: A nuanced view

Lars P Feld, Christoph M Schmidt, Isabel Schnabel, Volker Wieland 22 March 2016



In our contribution to the first Vox eBook on the Eurozone Crisis (Baldwin and Giavazzi 2015), we emphasised two fundamental weaknesses of the Eurozone prior to the Crisis:

  • First, there was a lack of economic and fiscal policy discipline, accompanied by dysfunctional sanctioning mechanisms as well as flawed financial regulation, leading to the build-up of huge public and private debt and a loss of competitiveness;
  • Second, there was no credible mechanism for crisis response regarding bank and sovereign debt problems, which would have been able to reign in moral hazard problems and establish market discipline.

These institutional deficits amplified economic imbalances in the economically heterogeneous currency area and rendered the economies of some member states vulnerable to the Global Crisis. In its aftermath, Greece, Ireland and Portugal experienced government debt crises, which ultimately threatened the cohesion of the entire Eurozone. In Spain, a government debt crisis was averted as banks obtained European funds for recapitalisation. Nonetheless, this was a reflection of the same underlying deficiencies.

Thus, our assessment differs in subtle, albeit important aspects from the ‘consensus view’ as briefly summarised in Baldwin et al. (2015). Specifically, since flows of capital as well as goods and services are market outcomes, we would not implicate the ‘intra-Eurozone capital flows that emerged in the decade before the crisis’ as the ‘real culprits’. In a monetary union, substantial capital inflows from higher-income regions might very well support income growth in member states with low per-capita income. There is nothing pathological about that, as long as the classical forces of conditional convergence apply.

Problems arise, however, when increased public borrowing feeds consumption spending instead of capacity- and productivity-enhancing investment, as was the case in Greece and Portugal, or when increased private borrowing is motivated by excessive risk-taking stimulated by an insufficiently regulated and supervised banking sector, as in Spain and Ireland. Hence, it is the government failures and the failures in regulation and supervision leading to those excessive developments that should take centre-stage in the Crisis narrative.

Implications of this diagnosis

This diagnosis of the underlying causes of the Crisis has important implications for our assessment of the Crisis policy response. While the alleged consensus summary concludes that ‘the whole situation was made much worse by poor crisis management’, our view is that the ‘loans for reforms’ rationale underlying the rescue approach was not only sensible, since it was the only way to successfully address the underlying causes of the Crisis. It also worked and substantially improved matters.

This even holds for Greece, whose dismal performance in recent years is mainly a reflection of the fact that this economy has been much further off a sustainable path of economic development than had been realised before the Crisis. Ireland, Portugal and Spain have returned to capital markets and have been recovering thanks to successful consolidation and structural reforms, and, of course, substantial monetary easing. However, the continuation of the reform process in these countries is endangered by the recent political shifts towards less reform-friendly parties. In the case of Portugal, this shows up in markedly increased sovereign bond spreads.

Importantly, a disagreement about the underlying causes of the Eurozone Crisis is destined to lead to a different view as to how to design an institutional architecture that is able to safeguard the Eurozone against future crises. Instead of correcting imbalances alleged to be excessive according to a fallible statistical procedure, in our assessment this framework should foster economic and fiscal policy discipline so as to avoid an excessive build-up of public and private debt, and effectively reduce moral hazard problems in the public and private sector.

In its discussions of avenues towards a stable Eurozone architecture, the German Council of Economic Experts has repeatedly outlined such a framework, entitled Maastricht 2.0 (Annual Economic Reports 2012, para. 173, and 2013, para. 269; see GCEE 2015a). This is the concept that emerges when we subordinate all our considerations to the objective of retaining the unity of liability and control in all relevant fields of economic policy. Its complete adoption would have the potential to successfully address the major weaknesses of ‘Maastricht 1.0’, the pre-Crisis framework of the Eurozone, whose weaknesses have been sketched above.

A new framework for the Eurozone: Maastricht 2.0

The distinctive element of any conceivable Eurozone architecture is the extent to which fiscal and economic policy competencies and liabilities are shifted from the national to the European level. Ultimately, the only convincing and robust candidate proposals are those ensuring that in each relevant policy field, control over fiscal and economic policy action is accompanied by liability for the consequences of such action. Any divergence between these two aspects causes moral hazard and can result in serious political tensions.

With its concept of Maastricht 2.0, the German Council of Economic Experts proposes creating a long-term regulatory framework that is consistent with this underlying principle (Figure 1). This regulatory framework follows the idea of crisis prevention first and crisis management second, and consists of three pillars structured according to the extent to which responsibility is allocated to European level. It aims at ensuring financial stability, ascertaining fiscal stability and providing effective crisis management.

Figure 1. A solid framework for the Eurozone: Maastricht 2.0

Ensuring the stability of the financial system

The danger of systemic financial crises justifies a strong governmental role for regulatory and supervisory authorities. In a system that predominantly relies on national responsibility, risks might easily be shifted from national level to the shared central bank balance sheet. It is therefore advisable to design common supervisory and resolution mechanisms at European level. Therefore, these arrangements are a key element of our concept of Maastricht 2.0.

The establishment of the European Banking Union during the last few years indeed created this previously missing counterpart to the common monetary and currency policy. Arguably, the banking union still needs to be strengthened by further reforms such as the creation of a European banking or even integrated financial supervisor, which is institutionally independent from monetary policy and which integrates micro- and macroprudential supervision. Yet, with the broad transfer of supervisory, restructuring and resolution competencies to the European level associated with the idea of the Banking Union, European policymakers have already managed to ensure the desired unity of liability and control.

Ascertaining fiscal stability

Concerning fiscal and economic policy, two fundamentally different constellations would, in principle, be able to lead to an alignment of liability and control:

  • The transfer of fiscal and economic sovereignty to the European level and simultaneously the assumption of comprehensive joint liability by the European partners.

This approach requires establishing an effective central decision-making authority at the European level endowed with the power to enforce tax increases, spending cuts and structural reforms, i.e. labour market and social policies, in a country if necessary (problem of intervention rights).

  • The continuation of national sovereignty over fiscal and economic policy, excluding any joint liability for government debt.

This means that the no-bailout clause applies. Appropriate protection needs to be established to avoid that liquidity or solvency crises of individual member countries spread to the rest of the Eurozone, which may cause the no-bailout clause to be disregarded (problem of credibility).

Any attempt to implement the first option – which would require Eurozone members to give up their national budgetary autonomy – is doomed to fail. Given the imperfect state of European integration and the manifold cultural, economic and institutional settings across the Eurozone, it is highly unlikely that a democratically legitimised transfer of fiscal and economic sovereignty to the European level will happen anytime soon. Any half-baked implementation of this option, however, with substantial national control remaining vis-à-vis joint liability, would be the worst of all worlds. Therefore, the German Council of Economic Experts strongly advocates the second option of national sovereignty over fiscal and economic policy, even though we have to acknowledge that the credibility of the no-bailout clause is not easy to establish either.

For this reason, while fiscal policy should remain largely under national responsibility, according to Maastricht 2.0 member countries would be obliged to adopt responsible fiscal policy following three rules:

  • The no-bailout clause strengthens market discipline by ensuring that private lenders – not the other member countries – bear the consequences of unsustainable fiscal policies;
  • National fiscal policy is monitored on the basis of common fiscal rules defined by the Stability and Growth Pact and infringements are seriously sanctioned; and
  • National debt brakes and their monitoring prevent the accumulation of excessive public debt.

The forthcoming development of the rulebook should underpin above all the credibility of the no-bailout clause.

Due to their intimate link with the state of public finances, the Maastricht 2.0 concept stipulates that key aspects of economic policy and the economic policy framework, such as the organisation of the labour market, also remain a national responsibility. Supplementary arrangements such as a fiscal capacity, which partially shift the liability for irresponsible or imprudent national policy actions to European level, would not be consistent with this concept.

Over the course of the Crisis, the Stability and Growth Pact was effectively tightened, resulting in stronger European control of national financial policy. Five new provisions and one directive (the ‘Six Pack’) were added in 2011, surveillance and coordination (the ‘Two Pack’) were improved and the fiscal rules were anchored at national level through the Fiscal Compact in 2013. These reforms have addressed the main shortcomings of the original Stability and Growth Pact. Specifically, there is an additional focus on debt sustainability, in order to reduce the debt-to-GDP ratio when it exceeds 60%. Furthermore, they embody greater transparency and foresight, in particular with benchmarks for budget planning and the European semester. Finally, options for sanctioning have been expanded and a reverse qualified majority voting procedure has been introduced.

It has also become clear that the general economic and fiscal policy will remain to be regarded as a national responsibility for the time being. These developments have moved the regulatory framework of the Eurozone in the direction of our concept Maastricht 2.0. Yet, improvements are still needed for the reformed fiscal pillar to effectively prevent a repetition of undesirable fiscal developments, most importantly the determination of the responsible European institutions to maintain fiscal discipline.

Providing effective crisis management

According to Maastricht 2.0, explicit rules should govern how member states’ liquidity and solvency crises will be handled. Preparing for any ensuing crisis beforehand will have the important side-effect that the ECB will be prevented from feeling obliged to act as crisis manager, a step that will always be putting its independence at risk. The crisis mechanism in Maastricht 2.0 is designed to make funds available in a joint effort, but these funds can only be accessed with the approval of national governments and under strict conditionality. The rules should also ensure that sovereign debt restructuring, if required to restore debt sustainability, proceeds in an orderly manner. The case of Greece suggests, however, that the exit of a member country from the Eurozone has to be possible as a very last resort.

The European Stability Mechanism, which was established during the Crisis years, is a permanent crisis mechanism that provides financial assistance under strict terms in the event of crises that endanger overall Eurozone stability. Its resources are only available to countries that have ratified the Fiscal Compact. The release of funds requires a qualified majority of the votes in the European Stability Mechanism decision-making body, in which each member has a veto right. Thus, it comes very close to the crisis mechanism envisioned in Maastricht 2.0. Yet, the European Stability Mechanism will not bring about full market discipline until it is complemented by an insolvency mechanism for sovereigns.

Overall, while these reforms have addressed all three pillars of our concept, thereby increasing the stability of the framework, there arguably are still a number of important deficiencies that need to be corrected to complete Maastricht 2.0. Taking the current framework as the starting point of our discussion and completing the revitalisation of the original Maastricht idea could enhance the future stability of the Eurozone and relieve the ECB of its role as a crisis manager. This strategy would be superior to all practically conceivable alternatives at the present time. Indeed, despite all good intentions, the concepts implying deeper integration (which are under discussion now) share the deficiency that they lack convincing suggestions as to how to arrive at the unity of liability and control.

Disclaimer: The German Council of Economic Experts, of which the authors are members, is politically independent and stipulated by law to support all decision-makers in the economic and political sphere as well as the general public in Germany in forming their views about economic policy and its potential risks. To this end, every November it presents an annual report to the German federal government and the general public.


Baldwin, R, T Beck, A Bénassy-Quéré, O Blanchard, G Corsetti, P De Grauwe, W den Haan, F Giavazzi, D Gros, S Kalemli-Ozcan, S Micossi, E Papaioannou, P Pesenti, C Pissarides, G Tabellini, B Weder di Mauro (2015), “Rebooting the Eurozone: Step 1 – Agreeing a Crisis narrative”, VoxEU, 19 November.

Baldwin, R and F Giavazzi (2015), The Eurozone Crisis: A consensus view of the causes and a few possible solutions, A eBook, CEPR Press.

German Council of Economic Experts (2013), “Against a backward-looking economic policy”, Annual Economic Report, Wiesbaden, November.

German Council of Economic Experts (2014), “More confidence in market processes”, Annual Economic Report, Wiesbaden, November.

German Council of Economic Experts (2015a), “Consequences of the Greek crisis for a more stable euro area”, Special Report, Wiesbaden, July.

German Council of Economic Experts (2015b), “Focus on future viability”, Annual Economic Report, Wiesbaden, November.



Topics:  EU institutions Macroeconomic policy

Tags:  Maastricht, Maastricht 2.0, Eurozone crisis, Germany

Director, Walter Eucken Institute; and Professor of Economic Policy, University of Freiburg

President, RWI Essen and CEPR Research Fellow

Professor of Financial Economics, University of Bonn; Member of the German Council of Economic Experts; CEPR Research Fellow

Managing Director of the Institute for Monetary and Financial Stability (IMFS) and holder of the Endowed Chair of Monetary Economics, Goethe University Frankfurt

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