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The Eurozone Crisis – Policy Dilemmas

The Eurozone Crisis – Policy Dilemmas

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By: Mariam Tabatadze
Advisor: Purba Mukerji

December 17, 2012

By: Mariam Tabatadze
Advisor: Purba Mukerji

December 17, 2012

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Published by: Roosevelt Campus Network on Jun 18, 2013
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 1
The Eurozone Crisis
 – 
Policy Dilemmas
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more
 powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believethemselves to be quite exempt from any intellectual influence, are usually the slave
s of some defunct economist.”
- John Maynard Keynes
By: Mariam TabatadzeAdvisor: Purba MukerjiDecember 17, 2012
 Abstract: The causes of the Eurozone crisis can be traced both long-term, in the types of institutions and economic targets that were created as bases for the monetary union and short-
term, starting with Greece’s admittance of an extremely high debt.
There are various factorsdiscussed in this paper, which are thought to have created the crisis and economists fromdifferent schools of thought assign relative importance to each factor according to their beliefs.Similarly, decision-makers attempting to implement best possible policies to combat the current  social and economic issues, arrive at conclusions based on their ideological frameworks. Arguably, European leaders responded to the Eurozone crisis in a delayed, fragmented and inefficient manner due to their political, cultural and ideological differences. This paper attemptsto examine various economic schools of thought and demonstrate how they inform the policychoices of modern European decision-makers in their considerations of implementing the best  possible strategies to combat the economic crisis in the Eurozone area.
 
 2
Introduction
In order to understand the causes of the Eurozone crisis and the policy responses of the Europeanleaders, one must look at European political and economic history, as well as, different economicschools of thought and their impact on modern decision-makers. The creation of the EuropeanUnion and the Euro was a response to
the region’s violent pas
t (EU, 2012), where wars werecommon and often brutal
 – 
these hostile relationships culminated in World War I and World War II. Political and economic integration may be an effective tool to reduce and prevent conflict(UNECE, 2012) and the European Union is considered successful in this sense
 – 
since 1945, theregion has experienced a period of reconciliation and peacefulness (Brumfield and Sterling,2012). However, the creation of the Monetary Union and the Euro to increase economicintegration has proven to be more problematic. The Eurozone crisis has exposed flaws ineconomic convergence, as well as, the effectiveness of existing economic institutions, such as,the European Central Bank and political institutions, for example the European Council.This paper examines the Eurozone crisis and how its current issues are a reflection of alongstanding economic debate on the degree and nature of the government involvement in theeconomy. There are various policy recommendations from different economic schools of thoughton dealing with an economic crisis. Great economic thinkers (such as, Adam Smith and JohnMaynard Keynes to name a few), as well as, lessons from economic history, impact the decisionsof modern leaders in their considerations of implementing a policy during a debt crisis. While the
conservative, otherwise called “orthodox” or “neo
-
classical” economists generally recommend
smaller government involvement in the economy to promote the private sector and market
forces; the “heterodox” or “post
-
Keynesian” economists advocate for 
a greater governmentinvolvement in an attempt to stabilize the economy, when the private sector fails.
 
 3
In section one, there is an overview of the history of the creation of the Monetary Union andconsequently, the Eurozone. It discusses the various stages, treaties and economic tools, whichwere used in an attempt to create an integrated, coherent economic system. Section two is a brief overview of the causes of the Eurozone crisis, presented by economists from the two differentcamps identified above. Section three describes the fragmented and delayed response fromEuropean leaders, while also attempting to explain how ideological differences contributed to thedisagreement between France and Germany. In section four, there is a historical overview of various perspectives surrounding public debt and the role of the government involvement in aneconomy. Section five and six focus on the topic of austerity, the former attempts to put it in ahistorical context and the latter examines its controversial implementation in Greece. The lasttwo sections, seven and eight, discuss lessons from economic history in terms of successfulapplications of austerity measures and alternatives to austerity in the Eurozone crisis. The lastsection, attempts to summarize and bring the main arguments together, in order to provideconclusions of the research.
1. The Creation of the Monetary Union and the Eurozone
On January 1, 1999, 11 member countries of the European Union adopted a common currency
 – 
 the Euro. After an additional six countries joined, the EMU (economic and monetary union)united 300 million consumers. In order to create the Euro, exchange rates between Europeancountries had to be fixed. However, in comparison to other fixed exchange rate examples, thecountries involved had to give up more of their sovereignty, in terms of monetary policy, andhand it over to the European System of Central Banks (ESCB). There are mainly two reasonswhy the European Union decided to have a currency union:

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