The Third Pillar: How Markets and the State Leave the Community Behind

by Raghuram G. Rajan

In Europe, the move toward a common Euro currency allowed all countries to benefit from the low common nominal Euro interest rate. It was low because everyone trusted the inflation-averse European Central Bank to keep overall inflation low. Yet, in countries at the periphery that had historically not maintained a tight control over inflation, inflation was still high. This further reduced the effective cost of borrowing in those countries, for borrowers had inflated revenues to repay cheap Euro borrowing. Having endured the discipline (or cooked the books) to meet the entry requirements into the Euro, a number of countries abandoned caution as they found they could now borrow easily and cheaply. In Greece, the government splurged, expanding both government spending and government jobs.39 Not all European countries that got into trouble relied on government borrowing and spending. In Spain, a combination of a private-construction boom fuelled by easy credit and spending by local governments created jobs. In Ireland, it was primarily a bank-lending-fuelled housing bubble that did the trick. Regardless,

Making of euro crisis