The muddle-through approach to the eurozone crisis has failed to resolve the fundamental problems of divergence within the union. If this continues, and as Monday’s downgrade of Greek debt by Standard & Poor’s implies, the euro will move towards disorderly debt workouts – and eventually a break-up of the union itself – as some weaker members crash out.
The euro never fully met the conditions needed for it to be an optimal currency area. Instead its leaders hoped the lack of fiscal, monetary, and exchange rate policies would require accelerated structural reforms in their place. These, it was hoped, would see productivity and growth rates converge.
The reality turned out to be different. Paradoxically, the halo effect of early interest rate convergence allowed a greater divergence in fiscal policies. A reckless lack of discipline in countries such as Greece and Portugal was matched only by the build-up of asset bubbles in others such as Spain and Ireland. Structural reforms were delayed, while wage growth relative to productivity growth diverged. The result was a loss of competitiveness on the periphery.