Working Paper: CEPR ID: DP9521
Authors: Vito Polito; Michael R. Wickens
Abstract: This paper argues that the crisis was an outcome of EMU: setting a common monetary policy for countries with different initial inflation rates. The crisis countries were those with high inflation rates which then had negative real interest rates and consequently over-borrowed. Current policy discussions focus on crisis measures: fiscal, banking and political union, not avoiding another crisis. This paper suggests two ways to avoid a future crisis: offset an inappropriate monetary policy using fiscal policy; markets could better price loan rates by taking into account default risk. The paper shows that neither was done prior to the crisis.
Keywords: credit ratings; EMU; euro crisis; fiscal policy
JEL Codes: E52; E62; H63; H68
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| EMU's common monetary policy (E52) | economic crises in Eurozone countries (F44) |
| high inflation rates (E31) | negative real interest rates (E43) |
| negative real interest rates (E43) | excessive borrowing (F65) |
| ECB's inability to tailor monetary policy (E58) | crisis (H12) |
| failure to price default risk (G19) | lack of adjustments in borrowing costs (G21) |
| crisis (H12) | increase in borrowing rates for crisis countries (F65) |