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Keynes Fund


Summary of Project Results

The project aims at providing a rigorous perspective of the crisis in the euro area, reconstructing its financial history and assessing the consistency of leading interpretations against stylized facts and economic models.

Documenting the financial history of the euro-area crisis is a key building block for a comprehensive interpretation of the root causes of the current prolonged slump. The collection of detailed data on the dynamic of banking flows and portfolio allocation could help reconcile the different views on crisis, within a more balanced analytical framework.

By way of example, many commentators interpret the build-up of Target2 accounting imbalances across countries as an evidence of excessive borrowing by the debtor countries during the crisis. Yet, especially in the first phase of the crisis, Target2 imbalances corresponded to a massive withdrawal of credit by the core-countries’ financial institutions. Without a balance-of-payment constraint at national level (inconsistent with monetary union), these institutions were able to repatriate funds and disengage from loss-making and risky loans without suffering from any losses. The liquidity effects of these withdrawals, however, exacerbated the crisis in the debtor countries, consequently raising the overall costs of the crisis. Moreover, since possible losses on Target2 balances are ultimately guaranteed by the euro-area taxpayers, the ‘liquidity run’ by creditor countries’ intermediaries on the peripheral debt caused a shift of risk onto the euro-area citizens. Over time, Target2 balances also recorded capital movements and ‘capital flight’ across border. However, it is important to understand the nature of these movements in different phases of the crisis.

We aim at collecting and organizing evidence on:

  1. Capital flows across countries and in and out of the area

  2. The dynamic of banking crises and bailout

  3. The process of restructuring financial intermediation along national border

  4. The evolution of the balance sheet of financial intermediaries

  5. Policy initiatives at country and European levels

Based on this evidence, we will define different phases of the crisis, marked by both market and policy developments. As stressed by President Draghi in 2014, an effective European response to the crisis was long hindered by insufficient European institutional development in banking supervision and regulation, burden sharing, and fiscal cooperation. European policy makers were required to agree at the same time on urgent stabilization initiatives and a new financial and fiscal architecture. Political bargaining resulted in shifting incentives and destabilizing shocks. Insufficient institutional development often caused European initiatives to be implemented in the wrong sequencing, and with considerable delay, thus creating room for belief-­‐driven speculative runs.

Different phases of policy developments corresponded to different levels of cohesion and policy cooperation. To a large extent, the eruption of the euro-crisis coincided with a break down in intra-European cooperation, with country leaders pursuing contradictory agendas on their own initiatives.

A new phase in the crisis was marked by the agreement on the European Stability Mechanism (ESM). The conditionality of the ESM programme made it possible for the European Central Bank to announce a credible intervention policy to stabilize interest differentials in the euro area: the Outright Monetary Transactions (OMTs). The success of the OMTs created the policy premise for a renewed season of stricter and constructive cooperation, pushing forward institutional changes, especially as regards the banking system.


Research Output

The euro crisis in the mirror of the European Monetary System, Giancarlo Corsetti, Barry Eichengreen, Galina Hale, Eric Tallman, VOXeu, 15th February 2019

Abstract: Why was recovery from the euro area crisis delayed for a decade? The explanation lies in the absence of credible and timely policies to backstop financial intermediaries and sovereign debt and to thereby prevent problems in banks and bond markets from feeding on one another. This column adds light and colour to this analysis, contrasting recent experience with the 1992-3 crisis in the European Monetary System, when national central banks and treasuries more successfully provided this backstop.

VOXeu Article



Prof. Giancarlo Corsetti and Prof. Barry Eichengreen


Professor Giancarlo Corsetti is Professor of Macroeconomics at the Faculty of Economics, University of Cambridge. His research expertise is in International Economics and Open Economy Macroeconomics.


Professor Barry Eichengreen is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science, at Berkeley Economics, University of California and a former senior policy adviser at the International Monetary Fund.





Cambridge Working Papers in Economics (CWPE)



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