The target mechanism: Will it propagate or stifle a stage III crisis?

Abstract

Skeptics have long believed that the EMU faces a dangerous period in Stage III when the “legacy” currencies will still be in circulation. The issue of whether the EMU could collapse arises from whether a country can extricate itself from the treaty. I will look briefly at some of the legal questions concerning a breakup of the union, specifically focusing on some costs that would materialize. This paper mainly will consider the technical mechanism whereby a crisis will be propagated through the financial system of the union, if a crisis does arise. The crisis may emerge as a straight banking crisis and not as an attack on the permanence of the EMU at all. It may reflect a disbelief in the permanence of the union; even if this belief is erroneous, it is worth examining how the funds will flow across borders and how the system will be defended. Finally, there may be a crisis that is preliminary to the collapse of the union itself. I include some earlier work on the propagation of a crisis in Stage III and examine issues of timing and dynamics of an attack.