Quaderni del Dipartimento di Scienze Economiche e Sociali – THE CONVERGENCE ILLUSION: WHY EUROPE’S APPROACH TO THE FINANCIAL CRISIS ISN’T WORKING – AND WHAT TO DO ABOUT IT

By ANGELO FEDERICO ARCELLI and EDWARD P. JOSEPH

Serie Rossa: Economia – Quaderno N. 89 febbraio 2013 

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Abstract

The crisis of sovereign debt in Europe revealed the limits and anomalies of the Euro, the common currency for 17 European Union member states, which participate in the EU common market but are denied independent monetary policies, even during a period of severe economic contraction and illiquidity. Such rigidity has had some perverse effects, such as, in the wake of divergent pressure on interest rates, that capital flight from weak to strong countries, exacerbating political differences within the EU, even to the point of calling the Union’s continued existence into question.

The solution to the sovereign debt crisis and the restoration of confidence in the European project are critical for the long term stability and economic growth of the region, and for the stability of worldwide financial market. But such a solution lies not only in Eurozone members’ hands, rather, particularly in this moment, in US possible support and long term strategy. The opening to a renewed Transatlantic bond, eventually extended to a broader common market or at least a trade agreement, jointly with a clear path to a growing political integration of Europe may be the ways for solving credibly all market doubts on the future of Euro and the stability of financial markets.

Reversing the most serious adverse trends – as opposed to temporizing with ‘crisis response’ – requires a thorough understanding of the origins of the crisis and the continuing efforts to contain it, in Greece, including the prospects for stemming contagion to Spain and Italy. This paper explores those issues and, as well, the continuing political difficulties that plague European policy making. The implications for the US economy and global financial stability of continuing failure by Europe to confront difficult truths — and to take concerted action — are enormous.