The eurozone crisis, also known as the Euro area crisis, was a financial crisis that made it difficult or impossible for some countries in the euro area to repay or re-finance their government debt.
The Euro area crisis resulted from a combination of complex factors, including the globalization of finance; easy credit conditions during the 2002–2008 period that encouraged high-risk lending and borrowing practices; the 2008 financial crisis; international trade imbalances; real estate bubbles that have since burst; the Great Recession; fiscal policy choices related to government revenues and expenses; and approaches used by nations to bail out troubled banking industries and private bondholders, assuming private debt burdens or socializing losses.
One narrative describing the causes of the crisis begins with the significant increase in savings available for investment during the 2000–2007 period when the global pool of fixed-income securities increased from approximately $36 trillion in 2000 to $70 trillion by 2007. This "Giant Pool of Money" increased as savings from high-growth developing nations entered global capital markets. Investors searching for higher yields than those offered by U.S. Treasury bonds sought alternatives globally.
The temptation offered by such readily available savings overwhelmed the policy and regulatory control mechanisms in country after country, as lenders and borrowers put these savings to use, generating bubble after bubble across the globe. While these bubbles have burst, causing asset prices (e.g., housing and commercial property) to decline, the liabilities owed to global investors remain at full price, generating questions regarding the solvency of governments and their banking systems.
How each European country involved in this crisis borrowed and invested the money varies. For example, Ireland's banks lent the money to property developers, generating a massive property bubble. When the bubble burst, Ireland's government and taxpayers assumed private debts. In Greece, the government increased its commitments to public workers in the form of extremely generous wage and pension benefits, with the former doubling in real terms over 10 years. Iceland's banking system grew enormously, creating debts to global investors (external debts) several times GDP.
The interconnection in the global financial system means that if one nation defaults on its sovereign debt or enters into recession putting some of the external private debt at risk, the banking systems of creditor nations face losses. For example, in October 2011, Italian borrowers owed French banks $366 billion (net). Should Italy be unable to finance itself, the French banking system and economy could come under significant pressure, which in turn would affect France's creditors and so on. This is referred to as financial contagion. Another factor contributing to interconnection is the concept of debt protection. Institutions entered into contracts called credit default swaps (CDS) that result in payment should default occur on a particular debt instrument (including government issued bonds). But, since multiple CDSs can be purchased on the same security, it is unclear what exposure each country's banking system now has to CDS.
Greece hid its growing debt and deceived EU officials with the help of derivatives designed by major banks. Although some financial institutions clearly profited from the growing Greek government debt in the short run, there was a long lead-up to the crisis.
Direct loans to banks and banking regulation On 28 June 2012 Eurozone leaders agreed to permit loans by the European Stability Mechanism to be made directly to stressed banks rather than through Eurozone states, to avoid adding to sovereign debt. The reform was linked to plans for banking regulation by the European Central Bank. The reform was immediately reflected by a reduction in yield of long-term bonds issued by member states such as Italy and Spain and a rise in value of the Euro.
Less austerity, more investment There has been substantial criticism over the austerity measures implemented by most European nations to counter the Euro area crisis. US economist and Nobel laureate Paul Krugman argues that an abrupt return to "'non-Keynesian' financial policies" is not a viable solution Pointing at historical evidence, he predicts that deflationary policies now being imposed on countries such as Greece and Spain will prolong and deepen their recessions. Together with over 9,000 signatories of "A Manifesto for Economic Sense" Krugman also dismissed the belief of austerity focusing policy makers such as EU economic commissioner Olli Rehn and most European finance ministers that "budget consolidation" revives confidence in financial markets over the longer haul. In a 2003 study that analyzed 133 IMF austerity programmes, the IMF's independent evaluation office found that policy makers consistently underestimated the disastrous effects of rigid spending cuts on economic growth.International Monetary Fund: Independent Evaluation Office, Fiscal Adjustment in IMF-supported Programs (Washington, D.C.: International Monetary Fund, 2003); see for example page vii. In early 2012 an IMF official, who negotiated Greek austerity measures, admitted that spending cuts were harming Greece. In October 2012, the IMF said that its forecasts for countries which implemented austerity programs have been consistently overoptimistic, suggesting that tax hikes and spending cuts have been doing more damage than expected, and countries which implemented fiscal stimulus, such as Germany and Austria, did better than expected.Brad Plumer (12 October 2012) "IMF: Austerity is much worse for the economy than we thought" The Washington Post
According to Keynesian economists "growth-friendly austerity" relies on the false argument that public cuts would be compensated for by more spending from consumers and businesses, a theoretical claim that has not materialized. The case of Greece shows that excessive levels of private indebtedness and a collapse of public confidence (over 90% of Greeks fear unemployment, poverty and the closure of businesses) led the private sector to decrease spending in an attempt to save up for rainy days ahead. This led to even lower demand for both products and labor, which further deepened the recession and made it ever more difficult to generate tax revenues and fight public indebtedness.Kapoor, Sony, and Peter Bofinger: "Europe can't cut and grow", The Guardian, 6 February 2012. According to Financial Times chief economics commentator Martin Wolf, "structural tightening does deliver actual tightening. But its impact is much less than one to one. A one percentage point reduction in the structural deficit delivers a 0.67 percentage point improvement in the actual fiscal deficit." This means that Ireland e.g. would require structural fiscal tightening of more than 12% to eliminate its 2012 actual fiscal deficit, a task that is difficult to achieve without an exogenous eurozone-wide economic boom. Austerity is bound to fail if it relies largely on tax increases instead of cuts in government expenditures coupled with encouraging "private investment and risk-taking, labor mobility and flexibility, an end to price controls, tax rates that encouraged capital formation ..." as Germany has done in the decade before the crisis. According to the Europlus Monitor Report 2012, no country should tighten its fiscal reins by more than 2% of GDP in one year, in order to avoid recession.
Instead of public austerity, a "growth compact" centering on tax increases and deficit spending is proposed. Since struggling European countries lack the funds to engage in deficit spending, German economist and member of the German Council of Economic Experts Peter Bofinger and Sony Kapoor of the global think tank Re-Define suggest providing in additional funds to the European Investment Bank (EIB), which could then lend ten times that amount to the employment-intensive smaller business sector. The EU is currently planning a possible increase in the EIB's capital base. Furthermore, the two suggest financing additional public investments by growth-friendly taxes on "property, land, wealth, carbon emissions and the under-taxed financial sector". They also called on EU countries to renegotiate the EU savings tax directive and to sign an agreement to help each other crack down on tax evasion and avoidance. Currently authorities capture less than 1% in annual tax revenue on untaxed wealth transferred between EU members. According to the Tax Justice Network, worldwide, a global super-rich elite had between $21 and $32 trillion (up to 26,000bn Euros) hidden in secret tax havens by the end of 2010, resulting in a tax deficit of up to $280bn.
Apart from arguments over whether or not austerity, rather than increased or frozen spending, is a macroeconomic solution,Vendola, Nichi, "Italian debt: Austerity economics? That's dead wrong for us", The Guardian, 13 July 2011. union leaders have also argued that the working population is being unjustly held responsible for the economic mismanagement errors of economists, investors, and bankers. Over 23 million EU workers have become unemployed as a consequence of the global economic crisis of 2007–2010, and this has led many to call for additional regulation of the banking sector across not only Europe, but the entire world.
In the turmoil of the 2008 financial crisis and the Great Recession, the focus across all EU member states was to gradually to implement austerity measures, with the purpose of lowering budget deficits to levels below 3% of GDP, so that the debt level would either stay below -or start decline towards- the 60% limit defined by the Stability and Growth Pact. In order to further restore the confidence in Europe, 23 out of 27 EU countries also agreed on adopting the Euro Plus Pact, consisting of political reforms to improve fiscal strength and competitiveness; and 25 out of 27 EU countries also decided to implement the Fiscal Compact which include the commitment of each participating country to introduce a balanced budget amendment as part of their national law/constitution. The Fiscal Compact is a direct successor of the previous Stability and Growth Pact, but it is more strict, not only because criteria compliance will be secured through its integration into national law/constitution, but also because it starting from 2014 will require all ratifying countries not involved in ongoing bailout programmes, to comply with the new strict criteria of only having a structural deficit of either maximum 0.5% or 1% (depending on the debt level). Each of the eurozone countries being involved in a bailout program (Greece, Portugal and Ireland) was asked both to follow a program with fiscal consolidation/austerity, and to restore competitiveness through implementation of structural reforms and internal devaluation, i.e. lowering their relative production costs. The measures implemented to restore competitiveness in the weakest countries are needed, not only to build the foundation for GDP growth, but also in order to decrease the current account imbalances among eurozone member states.