The financial crisis in the eurozone: a balance-of-payments crisis with a single currency?

In a pegged exchange-rate system, a balance-of-payments crisis happens when there is serious mistrust of whether a debtor country holds sufficient international reserves to monetise a capital withdrawal at the ongoing exchange-rate parity. In the eurozone (EZ), doubts that banks and governments of peripheral countries could settle debts when they matured led to a massive capital outflow after the fall of Lehman Brothers and, especially, the first Greek sovereign-debt crisis. This has led some authors to hold that the situation in the EZ is a balance-of-payments (BoP) crisis. However, the European Central Bank (ECB) offset massive financial capital withdrawals with a huge inflow of reserves to the EZ periphery, making the international reserves constraint irrelevant. This invalidated the BoP view in other authors' opinion, who pointed out bad bank behaviour and a poor initial institutional design as the alternative root cause for the current mess. This position is known as the monetary sovereign (MS) view. In this paper, we provide a brief overview of the debate between both sides, with Cesaratto, as a representative for the BoP view, and Lavoie, De Grauwe and Wray, for the MS view, and discuss whether a reconciliation between these two positions can be possible. We step into the discussion to offer two additional arguments in favour of the second view: (i) A currency union requires a single monetary policy, as opposed to a fixed exchange-rate regime; TARGET2 balances combined with refinancing operations are an essential ingredient of monetary policy implementation. (ii) The current situation is more easily understood as another episode of financial instability after banks have granted huge amounts of credit (which they refinanced abroad). The situation got even worse because governments supporting troubled banks in their respective jurisdictions lacked a lender of last resort.