Remembering the Roots of the Eurozone Debt Crisis in the Search for Solutions


Eurozone Debt CrisisWhen reflecting on the Eurozone debt crisis, it is important to remember that while Portugal, Greece and Ireland have in common a lack of access to the bond markets, they differ in the causes of that common problem. As I have argued previously, Greece faces a debt crisis because successive Greek governments took advantage of the low interest rates afforded by Eurozone membership to borrow beyond their means. In the wake of the global financial crisis, the markets woke up and realised that lending to Greece as if Greece were Germany did not in fact make much economic sense, the result of which realisation was increasing spreads between German and Greek bond yields, to the point where the Greek government could no longer afford to borrow. In Ireland, on the other hand, a housing bubble formed as the result of easy credit extended by banks to private borrowers, a trend exacerbated by the common ECB interest rate, which was too low for the Irish economy at that time. When the housing bubble burst, the Irish government responded quickly with a guarantee to rescue over-exposed banks, thus transferring massive amounts of private debt onto the public balance sheet. While this description does simplify matters, the crucial point is that the roots of these crises were different and so any response by EU leaders should take account of these differences.

 Some commentary on Eurozone troubles makes reference to the Stability and Growth Pact (SGP), the main architecture for fiscal policy in Economic and Monetary Union (EMU). The SGP was originally agreed in 1997 and reformed in 2005. The 2005 reforms were widely criticised as weakening the SGP to the point of irrelevance. While there is some truth to such claims, even a strong SGP could not have prevented debt crises in Ireland or Spain, both of which states were well within the debt and deficit limits set by the pact up until the start of the financial crisis in 2007 (Ireland: 28.3% GDP and +0.2% GDP; Spain: 42.1% GDP and +1.9% GDP).

 I do not mean to initiate a debate on the pros and cons of the SGP, but rather to call attention to the inadequacy of existing policy parameters for Eurozone governance. If a solution is to be found for the Eurozone’s problems, there is a need to consider how the distinct roots of the debt crises speak to the need for long-term solutions that address economic divergence across the Eurozone. Proposals for Eurobonds backed by the whole of the Eurozone or for expanding and institutionalising the European Financial Stability Facility are welcome, as is the idea of establishing a Eurozone Finance Minister. Yet the political will for even these modest changes appears lacking. What chances, then, for the bold idea of much deeper integration in the ultimate direction of fiscal federalism? Given that negotiations over the EU financial framework for 2014-2020 look set to develop into an acrimonious debate over modest increases to the current EU budget (roughly 2% of GDP), I doubt the political viability of permanent, large-scale fiscal transfers across the Eurozone any time soon. But attention should be paid, nonetheless, to mobilising Europe’s citizens in support of much deeper economic integration if the Eurozone is to survive.         

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