European Debt Crisis: Overview.

Introduction

The European debt crisis was a financial emergency affecting several member countries of the European Union (EU) beginning in 2009. In particular, the crisis affected EU countries in the Eurozone, the term used to refer to countries that share the euro as a common currency. The crisis was rooted in massive government debts held by Eurozone countries and their inability to repay these debts. These debt problems were most prominent in the southern European nations of Portugal, Spain, Italy, and Greece, as well as Ireland, but affected several smaller countries as well, notably including Cyprus and Malta.

To prevent widespread bankruptcy in the Eurozone, less indebted nations—mostly northern EU countries, especially Germany—injected funds into the European Central Bank (ECB) to prop up the troubled nations. In return for those funds, creditors demanded that the countries receiving financial assistance implement austerity programs, or economic programs stressing fiscal discipline. These programs included tax increases, cuts in government spending, cuts in pension programs, and labor-market reforms. Even before the crisis began, many Eurozone countries were suffering from recessions and rising unemployment. People feeling the pinch of a tightening economic vise met the demand for austerity with large protests. Voters in several countries replaced their government leaders with anti-austerity figures. The widespread economic disruption also contributed to a surge of Euroscepticism and nationalism across the continent, as some citizens of more stable countries resented the bailout programs.

Even with the infusion of hundreds of millions of dollars of capital into countries troubled by sovereign debt, it took years for EU officials to stem the debt crisis. Well into the 2010s, many analysts feared that economic collapse and related political unrest would continue to spread, threatening the very existence of the Eurozone and the EU. Meanwhile, the European debt crisis presented serious challenges for the entire global economy, including the economy of the United States. According to the Office of the United States Trade Representative, total trade between the EU and the United States supported about 7 million jobs in 2010 and generated $2.7 billion per day in 2013. This trading partnership not only consisted of goods and services; it also involved a complex network of relationships between banks and financial institutions. Some economists worried that the US economy would suffer if the Eurozone or the EU collapsed, although others argued the impact would be minimal—and some even suggested that a breakup of the Eurozone could benefit the US in the long term.

Ultimately, the debt crisis began to stabilize in the mid-2010s. Several national bailout programs ended by late 2014 as economic conditions improved. Nevertheless, the effects of the crisis continued to be felt through the late 2010s and into the 2020s. Although the Eurozone remained intact, observers continued to debate EU economic policy and its complex global impact.

Understanding the Discussion

Asset bubble: Term used to describe a condition in which the price of a particular asset is overinflated. For example, the term housing bubble refers to a period of time in which real estate is bought and sold at prices far above its actual worth.

Easy credit: Market conditions, such as low interest rates and low standards for borrowers, that make it easier than usual for consumers and businesses to obtain loans.

Euro: Official currency of the Eurozone.

European Central Bank (ECB): Institution responsible for monetary policy in the Eurozone; analogous to the US Federal Reserve.

Federal funds rate: In the United States, certain institutions with surplus money can lend that money by depositing it at the Federal Reserve, where other institutions in need of money can borrow it. The rate at which the money is lent is known as the federal funds rate.

Fiscal policy: Rules, guidelines, and laws that regulate taxation and government spending.

Monetary policy: Regulations relating to a state’s money supply, especially influencing interest rates.

Sovereign debt: Debt held by nation-states, owed to international institutions and other nation-states.

History

The European debt crisis had many causes. However, most economists agree that it was rooted in the world economic downturn that began in 2007–8. The downturn caused a decrease in tax receipts in several European countries, while their spending on their social safety nets remained the same or increased. In addition, despite the warnings of the global financial downturn, many countries chose not to decrease spending in other areas, such as defense.

The economic downturn began when the housing bubble in the United States burst. Millions of people found themselves unable to continue making payments on loans for homes whose prices were greatly inflated by the market. As more and more mortgage defaults occurred, a large number of US banks failed. Those that survived needed bailouts in order to continue conducting business. In addition, many healthy banks stopped lending entirely, except to the most trustworthy of lenders, such as the United States Treasury. Individual investors and investment groups took the same approach: they were willing to invest in US Treasury bonds, but not, for example, the bonds of Eurozone countries, which they viewed as more of a risk.

The economic downturn resulted in the first recession in the history of the Eurozone. Germany, the Eurozone’s largest economy, suffered its most severe recession since World War II, according to the German newspaper Der Spiegel. In response, the German government enacted a stimulus plan that amounted to an added 50 billion euros in spending, aimed at stimulating the country’s economy. Other Eurozone nations also enacted various measures, including additional government spending. The Eurozone recession ended in the third quarter of 2009.

Unemployment in the US peaked at 10.1 percent in 2010, its highest mark in over twenty-five years. It remained over 8 percent through mid-2012, staying high above historical standards. The stock market lost almost 53 percent of its value between its high in October 2007 and its low in March 2009. The market losses wiped out many Americans’ retirement funds and, coupled with high unemployment, cut into consumer spending and overall economic growth. The drop in housing prices further wiped out a significant chunk of Americans’ net worth. The culmination of all these events is now referred to as the “Great Recession,” the worst period of economic contraction in the United States since the Great Depression.

Policymakers implemented both monetary and fiscal measures to combat the recession. On the monetary side, the Federal Reserve moved to decrease the federal funds rate in an attempt to increase available capital. The Federal Reserve decreased the rate not just to a record low but to as little as possible, between 0 percent and 0.25 percent. On the fiscal side, the US government implemented a series of tax cuts and introduced additional spending, including a federal stimulus program worth over $780 billion.

In Europe, however, increased budget deficits resulted in some Eurozone nations violating certain previously established deficit and debt rules. In order to enter and remain in the Eurozone, countries have to satisfy the euro convergence criteria (sometimes referred to as the Maastricht criteria), and the Greek government was discovered to have submitted economic data that falsely demonstrated the country’s accordance with the criteria. In 2010, Eurostat, the branch of the European Union responsible for economic data, revised the Greek debt and deficits to their real numbers. Those numbers were not only far outside the criteria but astonishingly high for any nation—so much so that ratings agencies demoted Greece’s debt rating to junk status. As a result, the country’s borrowing costs soared, and the Greek government required bailout loans and guarantees from the International Monetary Fund (IMF) and other Eurozone nations. For the first time, a sovereign nation state—not simply a private bank—required a financial bailout, and the bailout came with conditions. Greece was required to implement an austerity program that meant cutting government spending and increasing taxes. The austerity measures resulted in the elimination of pensions, pay cuts for state employees, and increases in taxes. Greek citizens reacted angrily, and large demonstrations erupted across the country, some of them resulting in vandalism and violence.

The debt problem did not end with Greece. In November of 2010, the IMF and the EU initiated a financial bailout of Ireland. In May 2011, Portugal was bailed out. In June 2012, both Cyprus and Spain requested funds to help bail out their banks, the latter marking the first time one of the Eurozone’s major economies required emergency funds. Spain’s financial emergency raised concerns about even wider financial contagion, as some economists worried that the sums needed to stabilize the large Spanish economy could strain the finances of the entire EU and the IMF, in turn threatening the entire global financial system. The fact that Spanish and Cypriot banks joined the ranks of those needing bailouts was also viewed by economists as especially problematic because many of those banks had been among the major lenders to their own governments and other governments across the EU and beyond. When such banks do not have the resources to lend to governments, then the governments have to turn to other sources, such as banks outside the EU. However, due to the poor financial conditions of the nations in need of loans, few other banks were willing to lend to them. As a result, the Eurozone nations in the worst financial condition turned to other nations and international institutions such as the IMF for funds to keep their governments functioning, but those avenues of funding also could be problematic. Solvent countries who are lenders, in addition to facing the dissension of their citizens, can only lend a certain amount of money before risking their own financial stability.

The European Debt Crisis Today

Much of the discussion among economists and financial analysts focused on structural problems in the Eurozone itself. For example, the Eurozone is a “common market,” meaning that member countries do not earn money on import and export tariffs for most goods and services traded between member nations. It is also a monetary union, with a single central bank that sets the monetary policy for all members and has sole power to issue currency. Many analysts suggested that a strong fiscal union would help stem the Eurozone question by allowing for the group to take collective responsibility for debts and debt repayment. Countries critical of this plan, however, argued that a tighter fiscal union would result in a loss of sovereignty over fiscal issues within their borders.

In late 2011, German chancellor Angela Merkel—arguably the most influential leader in the EU at the time—announced her support for a stronger fiscal union. In March 2012, all EU members except the United Kingdom and the Czech Republic signed the Fiscal Stability Treaty. By 2014, all twenty-five countries that had signed the treaty had implemented it. The treaty nevertheless remained controversial and was vehemently opposed by many citizens and government officials within the EU. In March 2015, the euro hit its lowest level against the US dollar since 2003, signaling ongoing financial turmoil.

Although EU and IMF efforts to address the crisis were hotly debated, they gradually began to show results. Through the mid-2010s, most of the highest-risk economies stabilized and the threat of a complete Eurozone collapse diminished. Bailouts ended for Ireland in December 2013. This was followed by Spain in January 2014, Portugal in May 2014, Cyprus in March 2016, and finally, Greece in August 2018. In addition to negotiating bailouts, the ECB also initiated quantitative easing (increasing monetary supply by buying government securities) and attempted to standardize banking regulations throughout the EU through a banking union. Still, intense debate continued over how to prevent future economic threats, including whether the ECB should institute a Eurozone-wide deposit insurance rather than just national-level deposit insurance programs and whether the EU should adopt shared fiscal policy.

The effects of the Great Recession and the European debt crisis remained evident into the 2020s, despite overall recovery. Europe's financial woes were seen as having contributed to the rise of ethnonationalism, right-wing populism, and anti-EU movements in many countries. Some financial situations, such as Italy's still-high debt load, also continued to worry many observers, who feared another sovereign debt crisis might be looming.

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