"Competing Explanations of the Eurozone Debt Crisis and Their Consequences"

The emergence of large debt imbalances in the Eurozone during the run-up to the sovereign debt crisis is commonly attributed to the lack of debtor states competitiveness in world markets.  This "competitiveness thesis" has served as an important justification for the internal devaluation strategy that creditor state governments and European institutions pressed debtor states to pursue (a strategy that involves the combination of budgetary austerity and labor market liberalization). Contrary to the "competitiveness thesis," there is much evidence to suggest that the prime driver of  peripheral country debt was the "demand shock" that these economies experienced following monetary union: a demand shock that was intensified by the Eurozone's peculiar macro-economic governance structure and involved the channeling of excess creditor state savings to debtor states via the Eurozone's integrated banking system. The paper lays out the evidence for this alternative interpretation of the crisis and elaborates on its implications. It explains why internal devaluation by itself is likely to backfire and why current reforms of the Eurozone's macroinstitutional governance structure are not sufficient to prevent future iterations of the financial market dynamics that produced the debt crisis.