ABSTRACT
Since 2010, the financial crisis has raged across Europe, taking down governments of several members of the euro-zone in the process. Despite strong pressure for reform, and many meetings of heads of state, the problems are far from over. The crisis has been widely represented as a sovereign debt fiasco and a failure of fiscal policy by five peripheral member states (Greece, Portugal, Spain, Italy, and Ireland). However, the real causes of the predicament of the euro-zone are more complex. A satisfactory understanding of the crisis is only possible if we distinguish among four phases: background factors, including structural flaws in the original design of the Maastricht Treaty; capital flows and fiscal deficits; dynamics of divergence, especially regarding competitiveness; and the crisis dynamics. In this contribution we identify three sets of factors — i.e., market spillovers and policy externalities, insufficient information related to the management of risk, and perverse incentives related to the configuration of rules and institutions — that may lead to inefficient international outcomes in the environment of structural interdependence and full capital mobility, address how policy coordination can improve the results, explain how the euro-zone crisis developed, and explore a number of possible solutions.
