As a starting point for the analysis of the crisis, it is helpful to recall the institutional set-up of the European Monetary Union. When EMU was established, monetary policy was centralised while fiscal and economic policies remained in national hands. This set-up created vulnerabilities. It gave rise to a deficit bias, allowing the costs of fiscal imprudence to be partially shifted to other countries.
If the fiscal situation in one country is unsustainable, this implies repercussions for the monetary union as a whole. Moreover, abandoning the national currency in favour of a single currency has two major implications. First, member states cannot regain lost price competitiveness by depreciating their currency against their trading partners’ currencies and internal devaluation as a substitute is much more painful.