Economics Working Paper WP12104
The Euro area is still struggling through its debt crisis. The Greek Crisis may be temporarily on hold with the structured default that is currently being concluded. Continued forced austerity in that country and a political backlash to it may end in a real disorderly default in the not too distant future and a possible exit from the euro. Portugal may follow with a structured default. The crisis for the rest of the euro area is being presently ( temporarily?) alleviated by generous ECB liquidity to the banks, a modest fiscal compact, some bank recapitalization and moves toward moderate structural reforms.
Many of Europe’s woes could have been predicted from what is known about the history of monetary and fiscal unions and the theory of optimum currency areas. The creation of successful national monetary unions in the past always coincided with the set up of a fiscal union as part of the creation of a nation state ( Bordo and Jonung 2000). The theory of optimum currency areas developed half a century ago posited that a monetary union without full labor mobility required a fiscal authority to make transfers between subnational units ( Mundell 1961).