The origins of the Greek-sovereign debt crisis were the country’s large fiscal and external
imbalances. The key factor that abetted those imbalances was the absence of a short-tomedium
term adjustment mechanism — due to perceptions of sovereign bailouts — in the
euro-area that would have reduced members’ external imbalances. This situation
contrasts sharply with the adjustment mechanism under the classical gold standard. Under
the gold standard, countries with external deficits would experience losses of gold
reserves, higher interest rates, lower money and credit growth, and reductions in wages
and prices, which helped restore trade competitiveness. We draw two main conclusions.
First, the durability of a monetary union is crucially dependent on the existence of a wellfunctioning
adjustment mechanism. Second, adherence to a hard peg is no panacea and
cannot be sustained without the support of credible fiscal institutions.