Sovereign Debt or Balance of Payments Crisis? Exploring the Structural Logic of Adjustment in the Eurozone

This paper provides an alternative interpretation of the euro crisis to the dominant sovereign debt narrative. I argue that at the core of the euro crisis is a balance of payments disequilibrium—only this time the balance of payments crisis is taking place within a common currency. The frame of reference—sovereign debt crisis or balance of payments crisis—makes a significant difference not only for determining the causes of the euro crisis but also for the adequacy of policy measures to address the crisis. The sovereign debt crisis narrative has missed the interrelated nature of the macroeconomic imbalances within the eurozone. Despite the expectation of many observers at the time of the creation of the euro that the common currency would distribute the burden of adjustment more evenly across its member countries, the reverse is actually true. Compared to the European Monetary Union's predecessor regime, the European Monetary System (EMS), deficit countries are saddled with even higher adjustment costs in the common currency than before. In particular, they no longer have the tool of a nominal exchange rate change to address balance of payments disequilibria. This situation allows surplus countries—most importantly Germany—to exercise leverage over the key bargaining issues at stake in solving the eurozone crisis.