The Euro’s Three Crises

Abstract

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.