The role of monetary policy in addressing the crisis in the euro area

Beneath the surface: the root causes of the crisis in the euro area
Within the limits of our mandate we have acted with determination. Our balance sheet has expanded substantially, to almost three times its pre-crisis size. While it has shrunk since its peak, the expansion is comparable to the increase in the balance sheet of the Fed during the crisis. [3]

Tail risks have been largely removed from the pricing of euro area assets. Financial fragmentation has been receding: banks in stressed countries have seen the deposits placed with them by euro area residents increasing by about 130 billion euro since August 2012, TARGET2 balances of the National Central Banks in these countries have declined by more than 200 billion euro or about 20% since their peak and also banks' dependence on ECB liquidity intermediation is waning to some extent.
Nevertheless, problems in the euro area economic landscape still loom large. This understandably triggers calls for more action to be taken by the authorities that shoulder the responsibility to navigate the economy through these troubled waters.
To address these calls, one needs to take a sober look at the root causes of this crisis.
Most of the stressed euro area economies –and certainly the ones that are finding it most difficult and painful to adjust– have suffered from a chronic loss of competitiveness while being members of the monetary union. The erosion of their competitiveness has meant that these economies started running large current account deficits and some of them have accumulated large external debt positions.
In some cases the expanding external debt was driven by increasing public sector indebtedness. Imprudent fiscal policies were masking the private sector's lack of competitiveness in an effort to shield and even improve living standards.
In other countries it was the banking sector's leverage that increased fast. This in turn reflected a strong increase in lending to domestic firms and households. In these cases the lack of competitiveness was triggering a shift of the economies towards domestic consumption and activities shielded from international competition, such as the housing sector.

On top of that, banking supervision and regulation did not always mitigate the destabilising tendencies. There were cases when banks were not induced to develop sufficient capital and loss buffers in good times.
The way out is to restore competitiveness. And the way to do this in the context of a monetary union is to pursue with determination an ambitious structural reform agenda. Such an agenda comprises a number of national measures to make sure that the functioning of product and labour markets is fully compatible with participation in monetary union. One specific aspect is to fight vested interests that hamper competition, structural weaknesses of productivity and to allow, where needed, the nominal adjustments to play out.

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