Martin Wolf: Why the Irish crisis is such a huge test for the eurozone
04 December 2010
In his FT column, Martin Wolf warns that credit crises could replace currency crises - and these are likely to be even worse.
Why would a currency union lead to credit crises? One answer is that divergences in relative costs lead to structural trade imbalances – large external deficits when the less competitive economies are close to potential output. The private or public sectors must then spend more than their incomes to sustain full employment. Such excess spending must, in turn, be financed from abroad. In the end, such lending will vanish. If the lending goes via the banking sector, as in Ireland or Spain, there will first be a financial crisis. If the lending goes via the public sector, as in Greece, the crisis will first be in state finances.
© Financial Times
