BPEA | Spring 2012

The Euro’s Three Crises

Discussants: Hélène Rey and Ricardo Reis
Ricardo Reis headshot
Ricardo Reis A. W. Phillips Professor of Economics - London School of Economics and Political Science

Spring 2012

The euro area faces three interlocking crises that together challenge
the viability of the currency union. There is a banking crisis: banks are
undercapitalized and have faced liquidity problems. There is a sovereign debt
crisis: a number of countries have faced rising bond yields and challenges funding
themselves. Lastly, there is a growth crisis: economic growth is slow in the
euro area overall and unequally distributed across countries. These crises connect
with one another in several ways: the problems of weak banks and high sovereign
debt are mutually reinforcing, and both are exacerbated by weak growth
but also in turn constrain growth. This paper details the three crises, their interconnections,
and possible policy solutions. Policy responses that fail to take
into account the interdependent nature of the problems will likely be incomplete
or even counterproductive. A broader point also becomes clear: a currency
union may not need a fiscal union, but it does likely need both a financial union
and some way to adjust for unbalanced economic conditions across countries.