Causes of The Eurozone Crisis: A Summary
Causes of The Eurozone Crisis: A Summary
Causes of The Eurozone Crisis: A Summary
Standard Note:
SN06831
Last updated:
21 February 2014
Author:
Daniel Harari
Section:
The reasons for the eurozone crisis are many and varied, with some general causes and
some country-specific factors. A summary of the key issues are provided in this short note.
The list is not exhaustive.
Whats happened
Over the past few years a number of countries in the eurozone Greece in May 2010 and
February 2012, Ireland in November 2010, Portugal in May 2011, Spain in July 2012 for its
banks and Cyprus in May 2013 have been forced into taking emergency loans from other
eurozone and EU governments and the IMF. These countries governments asked for these
loans when they became unable to fund their budget deficits at sustainable interest rates on
the financial markets and faced the prospect of defaulting on their debt.
In return for the loans, these countries signed up to implement economic reforms and public
sector austerity intended to reduce their budget deficits and make their economies more
competitive. So, inability to borrow money on the markets to fund deficits was the short-term
factor behind the crisis, but what were the underlying reasons behind it?
eurozone countries were in it together). Once the global financial crisis began in 2008,
investors thought again. Countries with high debt burdens and weak economies, such as
Greece, soon saw their borrowing costs rise.
Economic divergence and trade imbalances
As mentioned above, different economies in the eurozone were growing at different speeds
in the 2000s. Many of the countries that ultimately needed bailouts also saw their economys
productivity levels and competitiveness decline (due to higher labour costs) relative to the
eurozone average (and especially Germany) during this period. So, countries like Greece,
Ireland and Spain, who were growing strongly and buying lots of imports, were also
becoming less competitive internationally. The result was that a large trade deficit had to be
funded by high levels of public and private borrowing (which had become cheaper).
Once the financial crisis hit and borrowing costs starting rising for these countries,
confidence in their ability to repay this debt was called into question, making financing it more
difficult and expensive. The single currency also meant that the easy way to regain
competitiveness (at least in the short-term) of devaluing your currency was not an option for
these countries. Meanwhile, Germany had accumulated large trade surpluses during this
time, partly as a result of lowering its labour costs (through restraint in wage growth).
Response to the crisis
When the euro was created, no mechanism was set up to deal with debt crises such as
those seen since 2010. As a result, emergency rescue plans had to be drawn up and agreed
on the hoof. The long drawn-out affairs that became synonymous with these bailouts were
viewed unfavourably by many. It also created the impression that the larger eurozone
countries that were providing the bulk of the loans were split as to how best to resolve the
crisis. This lack of decisive action weakened confidence in international markets, prolonging
the crisis.
Country-specific factors
The reasons leading up to the crisis were different for each country. Some of these factors
are summarised very briefly below:
Greece (loans totalling 240bn) high public sector debt, generous public sector
benefits, chronic tax evasion and weak competitiveness.
Ireland (loans totalling 85 billion, including 17.5 billion from Irish Treasury and
National Pension Reserve Fund) declining competitiveness and property bubble
funded by banks which went bust and were taken over and underwritten by the state,
causing government debt crisis.
Portugal (loans totalling 78bn) moderately high private and public sector debt,
weak competitiveness, and anaemic growth.
Spain (loans totalling 41bn) an ailing banking sector had lent heavily to
construction sector before the housing bubble burst.
Cyprus (loans totalling 10bn) collapse of the banking sector (massive relative to
size of economy), partly due to links to Greece.
The majority of the loans provided to the countries were funded by other eurozone countries,
with the IMF also contributing.