A recent policy brief issued by the Centre for European Policy Studies [CEPS], written by Paul De Grauwe, Professor of Economics at the University of Leuven and Senior associate Research fellow at CEPS argued that only a more active European Central Bank [ECB] can solve the euro crisis.

The document states that the biggest threat for the eurozone is the contagion of the Greek sovereign debt crisis to the rest of the system.

If the Greek crisis could be isolated, it would barely matter to the eurozone as a whole. After countless emergency meetings of the European Council, European leaders have failed to isolate the Greek crisis and to stop the forces of contagion.

Government bond markets in a monetary union are extremely vulnerable because the national governments issue debt is a “foreign” currency, i.e. one over which they have no control. As a result they cannot guarantee to bondholders that they will always have the necessary liquidity to pay back the bondholders at maturity.

This is in contrast to countries, such as the UK or USA, who issue sovereign bonds in their own currencies, which allows them to guarantee cash will always be available for bond repayment.

The absence of this guarantee makes sovereign bond markets prone to contagion in much the same way that a banking system without a lender of last resort is prone to contagion.

In such a system, a solvency problem in one bank quickly leads to deposit holders in other banks withdrawing their savings thus setting in motion a general crisis.

This is happening in the eurozone and as the fear of default increases; interest rates rise and thereby turn a liquidity crisis into a solvency crisis.

Any country can become insolvent if the interest rate is pushed high enough.

The solution proposed is for the ECB to take on the full responsibility of lender of last resort in government bond markets, providing a guarantee of repayment.

Further steps towards political unification must then be taken to exercise effective control on the deficits of national governments.