Abstract
The euro zone crisis is commonly regarded as a sovereign debt crisis. This definition certainly applies to Greece, but the Irish case represents an almost pure specimen of a banking crisis voluntarily transformed into a sovereign crisis. A debt crisis in two small, peripheral economies could become systemic because the financial system of the euro area is overstretched and highly integrated. Had the Greek and Irish crises occurred when euro zone banks were strong and/or not very interconnected, the euro zone crisis would not have happened.
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We leave aside the question of why the build-up of the credit boom was ignored. Inflation targeting by central banks was probably one key reason. According to Borio and Lowe (2002), a low-inflation environment increases the likelihood that excess demand pressures show up in the form of credit growth and asset prices bubble rather than in goods price inflation. If this is the case, inflation-targeting central banks with a ‘myopic behaviour’ could contribute to financial instability (de Grauwe 2009; de Grauwe and Gros 2009).
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Gros, D., Alcidi, C. (2018). Euro Zone Crisis 2010. In: The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-349-95189-5_2983
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DOI: https://doi.org/10.1057/978-1-349-95189-5_2983
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