HOW THE EURO CRISIS EVOLVED AND HOW TO AVOID ANOTHER: EMU, FISCAL POLICY AND CREDIT RATINGS
Cardiff University and University of York
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: fiscal union, monetary and fiscal policy, credit ratings, default risk
JEL Classification: E52, E62, H63, H68
Acknowledgements: The views expressed in this paper are those of the author and do not necessarily reflect the views of Cardiff University and the University of York.
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