Abstract
The European Monetary Union is on the verge of collapse. It seems that the late Milton Friedman was right when he diagnosed that the single currency would not survive the first major economic crisis. However, the question still remains as to which economic mechanisms of the currency union have managed to turn the political and cultural heterogeneity of Europe into such severe external imbalances between Northern and Southern euro zone countries that doomsayers are no longer alone in foreseeing a break-up of the euro zone. The main research question addressed in the chapter is the extent to which the external debt accumulation of Southern EMU countries can be attributed to euro capital market integration. We suggest that basically differences in economic fundamentals, associated with the political and cultural heterogeneity of Northern and Southern euro zone countries, were transformed into the observed external imbalances when interest rates converged.
This chapter follows closely Farmer (Modeling the debt mechanics of the European Monetary Union. In M. Petersen (Ed.), Economics of debt. New York: Forthcoming with Nova science Publishers, 2012b).
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Notes
- 1.
Note first that the analysis of this chapter is confined to the period before the euro introduction and the outburst of the global financial crisis in 2008. Second, in line with Fagan and Gaspar (2008) most time series presented end by 2005.
- 2.
- 3.
The assumption of lump-sum taxes clearly clashes with European tax code reality. However, since this chapter does not focus on taxation for the sake of analytical simplicity lump-sum taxation is assumed.
- 4.
In view of the calm economic development of the 1990s and of the first decade of the twenty-first century up to 2008, a period which was termed the period of “great moderation”, these simplifying assumptions are warranted even though we now know better (see Chap. 8).
- 5.
Focusing on the period 1998–2008 the assumption of labor market clearing in Southern euro zone countries is empirically appropriate if one is ready to accept a natural unemployment ratio of approximately 5 % (see Pisany-Ferry 2012, 4). Periphery’s unemployment rate started to increase dramatically in 2009.
- 6.
To mimic the facts presented in Fig. 18.5 above we assume that physical capital comprises mainly housing investment.
- 7.
Lin (1994, 97) shows that this definition of the real exchange rate is consistent with those in standard textbooks as e.g. in Dornbusch and Fischer (1990, 184–185) where the real exchange rate \( e \) is defined as: \( e={EP \left/ {{{P^{*}}}} \right.} \) with \( E \) standing for the nominal exchange rate (price of domestic currency in terms of foreign currency) and \( P \) and \( {P^{*}} \) being the domestic and foreign price level, respectively.
- 8.
The reversal of this trend after 2008 is due to the collapse of GDP growth rates at the end of 2008.
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Farmer, K., Schelnast, M. (2013). Modeling the Debt Mechanics of the Euro Zone. In: Growth and International Trade. Springer Texts in Business and Economics. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-33669-0_18
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