NBER WORKING PAPER SERIESENDING THE EURO CRISIS?Martin S. FeldsteinWorking Paper 20862 http:/www.nber.org/papers/w20862NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 January 2015The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.NBER working papers are circulated for discussion and comment purposes. They have not been peer- reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. 2015 by Martin S. Feldstein. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including notice, is given to the source.Ending the Euro Crisis? Martin S. Feldstein NBER Working Paper No. 20862 January 2015 JEL No. E5,E6,H2ABSTRACTAll of the attempts to end the euro crisis and to return the Eurozone countries to healthy growth rates of income and employment have failed. The options that are currently being discussed are not likely to be more successful.If there is a politically feasible way out of the crisis, it will be through revenue neutral fiscal incentives adopted by the individual Eurozone countries. I describe some of these fiscal options after reviewing the history of failed attempts and the options that are currently on the table.Martin S. Feldstein President Emeritus NBER 1050 Massachusetts Avenue Cambridge, MA 02138-5398 and NBER msfeldstnber.org1 ENDING THE EURO CRISIS? Martin Feldstein There may be no way to end the euro crisis. That was true even before the recent political developments in Greece. The euro faced difficult challenges from the beginning: an attempt to force a heterogeneous group of countries to use a single currency with a single exchange rate despite the lack of the de facto labor mobility and the large interstate fiscal transfers that allow the United States to operate successfully with a single currency. All of the attempts to end the euro crisis since it began and return the Eurozone countries to healthy growth rates of income and employment have failed. The options that are currently being discussed are not likely to be more successful. If there is a politically feasible way out of the crisis, it will be through revenue neutral fiscal incentives adopted by the individual Eurozone countries. I will describe some of these fiscal options after reviewing the history of failed attempts and the options that are currently on the table. The Origins The creation of the euro resulted in an immediate fall in the interest rates in those countries like Italy and Spain that had previously had high rates of inflation and interest. The lower rates of interest led to a surge in mortgage financed home building and in debt financed government spending. Financial markets came to believe that all Eurozone government bonds were essentially equivalent, causing interest spreads among those bonds to be very small. All was well until the Greek government revealed that it had previously underestimated the size of its national debt by a considerable amount. Professor of Economics, Harvard University. An earlier version of this paper was presented at the American Economic Association annual meeting on January 3, 2014, in a session entitled “When Will the Euro Crisis End?” 2 The market responded with a sharp jump in the interest rate on Greek debt followed during the next year by increased interest rates in the other Eurozone countries that had large amounts of government debt. By 2011 the government debts of Ireland, Portugal, and Italy exceeded 100 percent of their GDP and the interest rates on ten year bonds were over 12 percent in Ireland and Portugal and over 7 percent in Italy. With those interest rates, government budgets were in deficit and debt to GDP ratios were rising. Failed Attempts The Eurozone officials in Brussels and German Chancellor Angela Merkel responded to this situation by declaring that the crisis had to be solved at the level of the Eurozone, adding that the crisis was an opportunity to increase Eurozone solidarity. Their emphasis on higher taxes and budget austerity had the opposite effect: weakening economic activity in the peripheral countries, undermining solidarity, and producing strong anti-German sentiment. Despite the higher tax rates, the resulting decline in economic growth failed to reduce fiscal deficits and to stop the rise in the ratio of debt to GDP. Financial market participants then began to fear that the rising debt ratios would weaken the stability of the Eurozone itself, causing one or more of the member countries to leave the Eurozone and create a new national currency. European Central Bank (ECB) president Mario Draghi then came to the rescue in July 2012, declaring that the ECB would “do whatever it takes to save the euro.” The ECB then authorized financ