The euro, a common currency without common fiscal policy, faces a classic problem: each country is tempted to borrow, spend, and then unable to repay turn to the central bank to bail out its creditors. The euro was set up admirably to contain this problem, with an independent central bank that did not buy sovereign debts. Alas the initial framework left a few problems unanswered. In particular, in such a union sovereigns must in the end have to restructure debts, and banks must treat sovereign debt as risky. Yet the setup of the euro left no mechanism for sovereign restructuring or default, and banks to this day may treat sovereign debt as risk free. This means that banks make concentrated investments in their own sovereigns debts, so any sovereign default threatens the financial system. In turn, that makes it harder for the ECB not to intervene. We show how the initial structure was modified in a series of crises, to the point that the ECB now has a large portfolio of sovereign debts, is expected to intervene routinely to prop up sovereign debt, and countries and banks do not face the proper incentives to borrow and invest wisely. We recommend a sequence of reforms.
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WATCH THE SEMINAR
Topic: Crisis Cycle: Challenges, Evolution, and Future of the Euro
Start Time: February 25, 2026, 12:30 PM PT
