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Old 14th Jun 2012, 10:01
  #1486 (permalink)  
ORAC
Ecce Homo! Loquitur...
 
Join Date: Jul 2000
Location: Peripatetic
Posts: 10,050
Speaking of overborrowing - and forecasts of the fate of the Euro from the day it was founded.....

The Corner: A Euro-Zone/Twilight Zone Moment

While looking for a link to the second paper by Professor De Grauwe that I mentioned in the previous post, I came across (via Eurozoneremarks) something else he had written, together with some interesting background.

Here’s an extract from De Grauwe’s article:
Suppose a country, which we arbitrarily call Spain, experiences a boom which is stronger than in the rest of the euro-area. As a result of the boom, output and prices grow faster in Spain than in the other euro-countries. This also leads to a real estate boom and a general asset inflation in Spain. Since the ECB looks at euro-wide data, it cannot do anything to restrain the booming conditions in Spain. In fact the existence of a monetary union is likely to intensify the asset inflation in Spain. Unhindered by exchange risk vast amounts of capital are attracted from the rest of the euro-area. Spanish banks that still dominate the Spanish markets are pulled into the game and increase their lending. They are driven by the high rates of return produced by ever increasing Spanish asset prices, and by the fact that in a monetary union, they can borrow funds at the same interest rate as banks in Germany, France etc. After the boom comes the bust. Asset prices collapse, creating a crisis in the Spanish banking system.
This appeared in the Financial Times in February . . . 1998.
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