Eichengreen, Barry. "European Monetary Integration with Benefit of Hindsight". Journal of Common Market Studies, Vol.50, No.S1 (2012): 123-136.

Eichengreen, Barry. "European Monetary Integration with Benefit of Hindsight". Journal of Common Market Studies, Vol.50, No.S1 (2012): 123-136.

• Predictions for the European Monetary Union [EMU] did not predict the sovereign debt crisis that emerged in 2010, nor did they see how failures in the construction of the EMU could lead to these disasters (123).
• The main point that was missed was the need to make fiscal oversight and regulation part of the conditions for Eurozone membership outlined in the Maastricht Treaty and the need for effective banking regulation and oversight at the level of the EU (134).
• The basic analytical approach used to understand the EMU has been the optimal currency areas theory, developed by Canadian economist Robert Mundell in 1961. The theory identities the key strain in any monetary union being divergent supply and demand changes in different regions; the solutions to this strain are labor mobility and redistribution of capital to depressed areas (123-124).
• Use of the optimal currency areas theory by those creating the EMU was limited because there was very little scholarly work attaching the theory to real world conditions or issues. The scholarship that most influenced European Community leaders in the 1990s was on policies used to make monetary union work in the USA (124).
• Looking at the extremely mobile labor market and robust system of federal taxation and redistribution in the USA, European planners worried that they lacked the fiscal centralization and labor mobility to cope with asymmetric market outcomes in different states (124, 133-134).
• Economic trends between European states tended to be more divergent in the 1990s than different regions of the USA, but most of these divergences were caused by peripheral members of the European Community. Monetary union would be more sustainable if it included only the 'core European states' of France, Germany, the Benelux, and Denmark, as these states had more symmetric economies (124).
• The original plans for a monetary union were based in this assumption that it would be limited to a smaller subset of the European Community. This was implemented in the 1992 Maastricht Treaty, which limited future membership in a monetary union to those states meeting 'convergence criteria' based on deficits, debt levels, inflation, interest rates, and exchange rates (124-125).
• This plan did not work out, as countries like Italy, Ireland, Portugal, and Spain immediately joined the EMU, with even Greece joining in 2001. This was because some countries, particularly Greece and Italy, cooked their books to fraudulently meet the requirements; other countries implemented a brief period of austerity to achieve the correct figures in 1997, then returning to expanded spending after having met the criteria; and because standards for 'convergence criteria' were lowered to let Belgium in, despite its large debt, and further pushed down by France to allow more small economies to balance against Germany (125).
• Countries like Portugal and Greece, whose economic conditions did not apply well to monetary union with 'core Europe', were so eager to join the EMU because they believed joining would allow outside institutions to enforce fiscal discipline, because they feared being excluded from decision-making by Eurozone countries, and because they believed adopting the euro would increase income and labor productivity levels by reducing transaction costs, attracting foreign investment, and hasten technological and skills transfer from wealthier Eurozone members (125-126).
• These predictions about the benefits of joining the Eurozone were not well founded, as much economic theory would actually predicted greater divergence between rich and poor countries in the same monetary union. Poorer Eurozone countries also did not benefit in any of the expected economic ways, as labor productivity and incomes were not boosted (126).
• Joining the Eurozone did give poorer countries, like Greece, Italy, Spain, or Portugal, access to greater investment, but this capital was often channeled into asset bubbles and speculation. The main effect of greater availability of capital was that debt ballooned in these countries as credit was used to underwrite increased consumption, not investment (126-127).
• Experts were aware of this risk, warning countries with high inflation rates prior to the adoption of the euro would experience very low nominal interest rates, thus incentivizing borrowing (127).
• It was clear very soon after the creation of the EMU that peripheral countries were following the path of high consumption and indebtedness that would lead to the 2010 sovereignty debt crisis. After joining the EMU, they saw almost no increase in productivity, little investment outside of the housing market, an overvaluation of assets, and declining rates of savings (127).
• Europeans ignored the bad omens coming out of peripheral economies because it was profitable to do so, as German banks were making money lending to speculative Greek, Spanish, and Irish firms, who then made large amounts of money in real estate development. Until it collapsed, it was very profitable (127).
• Even in the late 1990s, there were significant doubts about the ability of the Stability and Growth Pact to actual provide fiscal discipline in the EU, largely because EU states were unwilling to sanction one another, a trait cemented in 2003 when France and Germany used their weight to avoid sanctions for surpassing the 3% deficit ratio rule. Moreover, it was recognized by economists that applying such sanctions could severely damage and potential trigger debt crises (128).
• Part of the reason that the 2010 sovereign debt crisis was not detected soon was that EU policies were too focused on fiscal deficits and ignored other defects in national economies. So, they detected chronic Greek deficits, but not the underlying issues in the Greek economy nor the high levels of unsustainable and unproductive private debt in Spain, Portugal, and Ireland (128).
• EU leaders have responded to the 2010 sovereign debt crisis by creating the 'Euro-Plus Pact' to expand surveillance of multiple different factors affecting economic competitiveness to Eurozone members plus Denmark, Bulgaria, Poland, Latvia, Lithuania, and Romania. This Pact has also synchronized budgetary proposal schedules to allow for easier fiscal oversight at the EU level. This Pact would also empower the European Commission versus the European Council, requiring the later to have a majority to overturn Commission decisions (128-129).
• This Pact does nothing to address the poor oversight of European banks, whose regulation is divided between separate national bodies, many of whom neglected their responsibilities in the lead-up to the 2010 sovereignty crisis. This is a major fault considering the scope of banking integration across EU countries (129).
• The EU did create a European Banking Authority, headquartered in London, by it remains to be seen whether it will be able to force greater transparency and more rigorous regulatory practices (129-130).
• The European Central Bank [ECB], modeled on the German Bundesbank, does not perform the traditional central bank role of supporting the financial system, instead concentrating its singular mandate of maintaining low levels of inflation. Since the 2008 global financial crisis, the ECB has been dragged into responsibilities providing emergency liquidity and emergency purchases of national bonds, both tasks it was poorly structured and prepared for (130).
• The EU also created the 'European Stability Mechanism', which comes into force in 2013 to replace the European Financial Stabilization Facility, to address sovereign debt issues. This body is tasked with reviewing the sustainability of national debts, issuing conditional loans to countries facing temporary crisis, and restructuring debts designated unsustainable (131). 
• The Stability Mechanism is supposed to function based on regulations on pre-designated economic models and levels that demand different actions. However, these economic levels are flexible and the Mechanism has lots of latitude to delay restructuring for political reasons (132).
• Restructuring debt like this is risky and likely won't be implemented immediately since the costs of the restructuring could collapse already weak banking systems holding sovereign debt assets. This is why no major restructuring of debts has occurred between 2008 and 2012. It is similar to the logic that led Latin American governments to delay the 1989 Brady Plan for debt restructuring for 7 years after the 1982 debt crises (131-132).
• The provision instituted by the Mechanism that all new European sovereign debt must contain provisions for restructuring reduces investor confidence in those assets since the inclusion of restructuring clauses is seen as increasing the risk of restructuring. For countries already perceived as having unsustainable levels of debt, this can make borrowing costs prohibitive (132).
• There are also worries that the Mechanism is not adequately funded to deal with future crises. It has been given 80 billion euros, much less than would be needed to deal with a crisis the size of Greece or Italy. The solution has been to give the Mechanism 'callable capital', meaning it has the right to ask EU member states for an addition 620 billion euros. However, member states would be the least able to provide this capital during a crisis and it would decrease reserves in wealthier countries, thus potentially spreading any crisis (133).
• The IMF provided ⅓ of the debt relief to Italy and Greece during their initial debt crises, with the EU providing the other 2/3s of the funds (131).