Eurozone Crisis: A Public in Denial

Europe’s leaders have been blamed for wasting time over rescuing Greece and the common currency. Yet it is their electorates who have failed to grasp the situation

On a recent visit to Europe, I found economists, journalists, and business people thoroughly frustrated with their politicians. Why, they ask, can’t politicians see the abyss that yawns before them, and come together to resolve the euro crisis once and for all?

Even if there is no consensus on what a solution might be, can’t they meet and thrash out a plan that goes beyond their repeated half-measures? It is only because of the European Central Bank’s bold decision to lend long term to banks that we have seen some respite recently, or so their argument goes. Politicians, in contrast, are failing Europe by being forever behind the curve. Why do they find it so hard to lead?

One answer that can be easily dismissed is that politicians simply don’t understand the gravity of the situation. Political leaders need not be economic geniuses to understand good advice, and many are both intelligent and well-read.

A second answer – that politicians have short time horizons, owing to electoral cycles – may contain a kernel of truth, but it is inadequate, because the adverse consequences of timid action often become apparent well before they are up for re-election.

The best answer that I have heard comes from Axel Weber, the former president of Germany’s Bundesbank and an astute political observer. In Weber’s view, policymakers simply do not have the public mandate to get ahead of problems, especially novel ones that seem small initially, but, if unresolved, imply potentially large costs.


Talk is cheap, and, in the absence of evidence to the contrary, the status quo usually appears comfortable enough. So leaders’ ability to take corrective action increases only with time, as some of the costs of inaction are experienced.

Calamity can still be averted if the costs of inaction escalate steadily. The worst problems, however, are those with “inaction costs” that remain invisible for a long time, but increase suddenly and explosively. By the time the leader has the mandate to act, it may be too late.

A classic example was Winston Churchill’s warnings against Adolf Hitler’s ambitions. Hitler’s plans were outlined in Mein Kampf for all to read – and he did not disguise them in his speeches. Yet few in Britain wanted to give them credence, and many thought that communism was the greater threat, especially in the bleak years of the Great Depression.

The Nazis’ dismembering of Czechoslovakia in 1938 made the sincerity of Hitler’s ambitions all too clear. But it was only after the invasion of Poland the next year that Churchill was appointed First Lord of the Admiralty, and he became Prime Minister only after the invasion of France in 1940, when Britain stood alone.

Britain might well have been better off had Churchill held power earlier, but that would have meant costly rearmament, which was unacceptable so long as there was a chance that Hitler proved to be a paper tiger. And, of course, it would also have meant entrusting Britain’s fate to a politician who, though now regarded as an indomitable leader, was widely distrusted at the time.

Non-linear costs of inaction are most obvious in the financial sector. At the same time, financial-sector problems may be particularly difficult to address: if politicians emphasize the need for action too strongly in order to get a mandate, they might precipitate the very turmoil that they seek to contain. Eurozone politicians have obtained a mandate to take bolder action only as the markets have made the costs of inaction more salient. Even setting aside Germany’s understandable attempt to limit its exposure, it is difficult to see how politicians could have got ahead of the problem.

While the ECB has bought the eurozone some time, the calming effect on markets may be a mixed blessing. Have Europeans seen enough of the abyss to tolerate stronger action by their leaders? If not, markets might have to deteriorate further to make a comprehensive resolution possible.



Raghuram Rajan is Professor of Finance at the Booth School of Business, University of Chicago, and the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy. Copyright: Project Syndicate, 2012.

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