Financial crisis could play a key role in changing the policy equilibrium concerning financial markets and institutions. Using a recent comprehensive dataset on financial liberalization across ninety-four countries for the period between 1973 and 2015, we formally test the validity of this prediction for the member states of the European Union as well as a global sample. We contribute by (a) using a new up-to-date dataset of reforms and crises and (b) subjecting it to a combination of difference-in-differences and local projection estimations. In the global sample, our findings on the causal relationship between crises and liberal reforms consistently point out a negative direction between the two, suggesting that governments react to crises by intervening in financial markets. However, in a dynamic setting with impulse responses, we also illustrate that such interventions are only temporary and liberalization process restarts after a financial crisis. In the EU sample, however, we do not find sufficient evidence to support either of these observations.

The financial crisis of 2007–2008, which led to the Great Recession of 2008–2009 and triggered the sovereign debt crisis in the euro area in 2010, has led to a lot of soul searching among professional economists. With the benefit of hindsight, it can now be said that these crises were misdiagnosed in two ways. First, many economists interpreted these crises to have increased the need for more flexibility in labour and product markets. Structural reforms aimed at making both labour and product markets more flexible were seen as the tools to boost economic activity and to launch countries into a higher growth path. Thus, although the initial shocks were understood to have originated from a financial and banking implosion, which led to a collapse of aggregate demand in 2009, many economists surprisingly advised to fix the supply side.

It has long been argued that structural reforms constitute a remedy for getting countries out of the low-growth environment that Europe has experienced in the last decade. Many recent studies show long-term benefits of such reforms in cross-country settings, but ignore the heterogeneity across different country experiences. To address this gap in the context of the European Union, we focus on the largest early reforms that its four members (Denmark, France, Greece and Portugal) adopted in financial and labour markets. By using a Synthetic Control Method, we find that many of these early reform episodes do not seem to have been as fruitful as their advocates claimed at the time. Our results indicate a rather mixed relationship between reforms and several macro measures, including economic growth and inequality. Reforms, especially when introduced all at once as a big-bang, do not seem to always produce the intended results.

Since the financial crisis started in 2007–2008, many advanced economies have struggled to return to their precrisis growth path. Although the recovery in the United States was relatively rapid, Europe’s wasn’t. A sovereign debt crisis led to a double-dip recession in the euro area. Unemployment soared, particularly youth unemployment in the periphery countries, and private and public investment experienced an extremely slow and protracted recovery with its precrisis level still not being reached in many countries. The experience has also been uneven across Europe’s core and periphery countries: from the form in which reforms were designed and implemented to the depth and speed of the recovery.

Most European citizens (outside Germany) take it for granted that monetary union can only be beneficial. This rosy picture of benefits of economic and monetary union (EMU) has been given a strong boost by the publication of a report by the Commission of the European Community entitled ‘One Market, One Money’. In this intellectual environment it is refreshing to read a paper like Paul Krugman's that contains a strong warning that EMU could also lead to great economic problems in the Community.

The essence of Krugman's argument can be summarized as follows. Increased market integration leads to more specialization of industrial activities. In a world of increasing returns, this is likely to lead to regional concentration of industrial activities. As a result, shocks in demand are more likely to have asymmetric effects, with some regions (and countries) being affected more severely than others. In addition, with free factor mobility, factors of production move quickly from the region (country) which is adversely affected towards regions (countries) that experience a positive demand shock. Thus, asymmetric shocks tend to have permanent effects on the growth rates of regions and countries. The implications for EMU are that the macroeconomic adjustment problem in a future monetary union will be intense, because countries will no longer be able to use the exchange rate as a policy instrument while they will be subject to more rather than fewer asymmetric shocks. The only way this adjustment problem can be made less severe is by centralizing a significant part of the national budgets so that the automatic inter-regional redistributive mechanism can play a role in the future EMU.