Germany and the Euro: The Reluctant Leader

The euro crisis has underscored the critical role that Germany plays in the regional architecture.  Importantly, the German government has persistently and often successfully pushed a policy response that is motivated by a concern in moral hazard by other member states. This has resulted in reluctance to quick and forceful commitments to regional bailouts. This is not to say that Germany has been paralyzed in the face of the crisis or absent. From Greek sovereign debt to Spanish banking, Germany has actively engaged the euro crisis and been an important member in the resolution team. But in these efforts, Germany has played the reluctant leader – cautious and circumscribed. This caution has not been without risk. A number of academic and policy analyses suggest that the halting response inflated the cost of the crisis by sowing the seeds of market doubt and sparking wider contagion.  It is then important to understand why policy alternatives stressing either German exports or the risk of contagion were rejected. The central argument of this chapter is that the timing of reunification and the German recovery from it relative to the timing of the euro crisis set in motion a series of political economy dynamics that favored the moral hazard response over the alternatives. In particular, structural reforms enacted in response to the post-reunification economic malaise as well as economic transfers resulting from reunification undermined solidarity impulses within the German electorate.