Crisis Cycle

Book Review

Crisis Cycle: Challenges, Evolution, and Future of the Euro - John H. Cochrane, Luis Garicano, and Klaus Masuch – Princeton University Press, June 2025, London, UK.

It is an open secret that the original flaws in the construction of the euro zone have still not been revised:

The EMU, European Monetary Union via Maastricht was built on monetarism. Monetarism, however, is a fiction. 

The fiction that there is a money supply that is controlled by an independent and technocratic central bank in a way that the desired inflation rate is achieved in the end.

This is the dream of many economists who believe that the money is neutral. But this assumption has absolutely nothing to do with reality. 

However, because people firmly believed in this fiction at the beginning of the 1990s, when the Maastricht Treaty was drawn up, a separation of monetary and economic policy was enshrined into the treaty that is completely unrealistic.

The authors - of this currently published book - note that they share a view that the euro and the EU are wonderful institutions. They emphasize that monetary, financial and fiscal policy are always intertwined. Yet this interaction can create incentive problems which refers to the so-called moral-hazard issue.

Their criticism is based on the fact that the EU institutions have not cleaned up after crises. This means that no sustainable framework for future monetary and fiscal policy coordination has been re-established, which would relieve the burden on the ECB. The EU and the member states should start a serious process to implement institutional reform.

They outline how monetary, fiscal and financial policies interact and they tell the story of how European policies and institutions have evolved under the pressure of four crises. Given the fragility of the current moment, the authors suggest ways to fix the architecture of the euro.

«To avoid the ECB stepping in again and again, we must complete the structures for which they laid the foundation»

The authors recommend reforms to restore a separation between monetary, fiscal and financial policies, while the book’s approach is based on “modern dynamic economic theory” (alongside of economic incentives).

Among other things, they imply that the ECB's independence has been compromised because it has implemented a QE policy. 

That is far-fetched. After all, central banks have been conducting open market operations for a long time. Buying bonds on the open market is one of them, without a doubt. And that has nothing to do with the ECB's political independence.

When discussing the sovereign debt crisis, authors often seem to forget that the financial crisis was the actual cause of the increase in government debt in the individual eurozone countries. There is no evidence of unsound fiscal policy in the financially weak countries – with the exception of Greece. Spain and Ireland for instance had fiscal surpluses and low debt-to-GDP ratios before euro crisis.

What is remarkable is that the authors are suggesting that fears about insufficient money supply constraining the economy (a core monetarist concern) are outdated in an era where central banks can and do create money as needed during crises. 

«Central banks today also aggressively address the macroeconomic facets of systemic runs. The greater demand for money does not meet a fixed supply. Central banks promptly lower interest rates and “inject liquidity”. Monetarist scarcity of means of payment is probably not an important economic problem.»

Yet when authors lead with charged language about "money-printing" and portray government debt (“compounding fiscal stresses”) as inherently "problematic" (or “endangering”) in the opening pages, it often reveals several things about their approach:

They're likely setting up a narrative that prioritizes certain economic values (like inflation control or balanced budgets) over others (like full employment or public investment) without acknowledging this is a value choice, not an objective truth.

This framing often overlooks that government finances operate differently from household finances. Government "debt" and monetary operations are complex policy tools with various purposes and consequences depending on context.

The alarmist tone about government borrowing may indicate the book is written to confirm existing biases rather than to educate readers about the nuanced realities of modern monetary systems. The neoclassical economics has failed.

Economic topics like government debt and monetary policy are so often presented in black-and-white terms, when the reality involves many shades of grey and legitimate debates among experts.

«Europe suffers from financial disunion and fragmentation»

The authors quote (approvingly) the so-called Draghi Report (2024) that Europe's problems are structural. However, the focus of the European discussion on competitiveness is more than questionable, while Germany has an enormous current account surplus (6% of GDP). Against this backdrop, it is no wonder that US President Donald Trump wants to respond with tariffs and other measures.

Furthermore, the Draghi report is mainly based on a microeconomic analysis, on case studies. However, this does not take us one step further in terms of EU reforms, as Europe fails in macroeconomic terms. It is no wonder that investment activity suffers and with it the development of productivity.

To conclude from the lack of investment momentum that European companies are not equipped for the right future fields is too short-sighted.

The “Triple Lock”

Three crucial provisions separate monetary and fiscal policy in the EMU draft: a ban on monetary financing of excess debt, limits on debt and deficits and a no bailout principle that member states may not bear the debt of others with fiscal resources.

Draghi report attributes the low investment activity in Europe primarily to the inefficiency of the European financial markets. This is untenable as well.

Note to self: The Maastricht Treaty has a crucial weakness. The EU Commission takes action against member states that favour individual companies in the private sector, e.g. through a subsidy. 

However, if a state favours private companies by lowering taxes and/or wage pressure, the EU Commission does nothing about it because this all falls under the category of “competition between nations”. 

Germany, for example, has gained advantages through a mercantilist trade policy (and a belt-tightening policy). The EU authorities overlooked, what was happening. A shortcoming of this book is that the authors do not address such parameters.

«If sovereigns cannot be allowed to default, it’s a fiscal union»

The prevailing monetarist idea of the book is somehow to make a clean sweep of the government debt and thus relieve the burden on the ECB. The rest is to be accomplished by the market, without intervention of the authorities.

There's hardly a page in the book without the word "default" appearing. It's virtually everywhere, every-where, the book's central theme.

Crisis Cycle: Challenges, Evolution, and Future of the Euro - John H. Cochrane, Luis Garicano, and Klaus Masuch – Princeton University Press, June 2025, London, UK.

According to the authors, the lessons of successive crises seem clear today. The EMU needs institutions capable of conducting a comprehensive restructuring. Regular bankruptcy laws and procedures are not well suited to sovereign restructuring. Such an institution should also be able to provide temporary fiscal support in a timely manner, and any ECB involvement must omit implicit fiscal support.

The authors reject general social spending because it “can quickly turn into perpetual subsidies preserving inefficient activities”.

European Fiscal Institution (EFI): A joint institution could be enshrined in the Treaty or constructed by intergovernmental arrangement.

A common fiscal and political institution of the euro area with the necessary instruments, powers and sufficient capital of the member states and with the participation of political leaders should be fully responsible for crisis management. 

The primary purpose of reforms is to dramatically reduce this accumulation of debt crises and probably also their frequency. «Restructuring might be somewhat more frequent in the beginning, but restructuring would not cause a crisis»

«The ECB must be unburdened from problems surrounding sovereign debt. Options for orderly sovereign default and debt restructuring need to be created»

A challenging book about a highly controversial topic (government debt and default) which is examined and illuminated by the strict principles of neoclassical theory. This academic piece of work may appeal to readers drawn to ascriptive premises of mainstream tradition.