The situation in southern Europe is mostly seen through the lens of Greece. The author claims that had Ireland asked for financial assistance first, then Greece would not be the center of the Euro crisis, but in fact it would be Ireland. Politically speaking, Ireland is a less attractive scapegoat because it involves a situation similar to that of the U.S. Debt to GDP ratio was 54% of GDP in 1998 and came down to 25% in 2007.
Greece on the other hand missed the 1999 entry into Euro and joined Euro in 2001. Covered up debt and budgetary deficit was never below 4.5% (Ceiling was 3%) Public Debt was 129% of GDP (60% benchmark). Greeks used more pension money, had a lower retirement age, and did not spend EU grants well.
Euro Crisis revealed two flaws in the Euro Area framework.
First is assumption that threats to stability would come from Public Sector. Private sector is also major source of instability.
The second mistake was assuming that monitoring deficits year after year was enough to prevent a public finance disaster. Financial crises often appear very suddenly and there needs to be a plan in place for when things go wrong.
The author goes on to say that blaming Greece for the crisis is an oversimplification of the problem: “Since the state is the insurer of last resort, its finances are vulnerable to all sorts of economic and financial shocks. Acknowledging this potential fragility and designing an adequate surveillance framework is more difficult than stigmatizing a small Mediterranean country for its (very real) turpitudes”
Inflation rates across the Euro area were very different, but the ability to spend was the same (interest rates). A Price differential occurred in non-tradable goods across the currency union, thus leading to differing rates of inflation. With the nominal interest rate being fixed for each country, real interest rates began to differ as a result of the differences inflation. This means that the ease with which households could borrow money depended on the inflation rate of the country they lived in. When Spain adopted the euro in 1999, interest rates dropped as a result of accelerated convergence. This resulted in lots of credit and massive real-estate investment. The net effect was Spain’s external deficit widened from 4% to 10%. Divergence in Euro Area become a problem around 2005 and 2006. Even worse, the Central Bank of Spain could not do much to fix this because interest rates are set by ECB.
In short, European institutions did not hold up their end of bargain to monitor inflation rates and ensure that they were similar across the Euro Area. Policy makers failed to act because they believed external deficits were not big deal in a currency union.