The Eurozone Crisis: Causes and Potential Solutions

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The Eurozone Crisis began in 2009 when investors became concerned about growing levels of sovereign debt among several members of the European Union. As they began to assign a higher risk premium to the region, sovereign bond yields increased and put a strain on national budgets.

Regulators noticed these trends and quickly set up a 750 billion euro rescue package. But the crisis persisted due in large part to political disagreements and the lack of a cohesive plan among member states to address the problem in a more sustainable way.

Learn about the Eurozone Crisis, its causes, solutions, and more.

Key Takeaways

  • The Eurozone crisis started in 2009 when several countries were warned about their high levels of debt.
  • European leaders agreed to a bailout. They imposed austerity measures to help the countries grow out of debt.
  • Measures taken by Euro leaders became very unpopular, but the crisis was dealt with in the end.
  • There are still debates over the financial stability of the area and how to prevent another crisis.

What Were the Causes of the Crisis?

The Eurozone Crisis began in late 2009 when Greece revealed that its debt had reached 300 billion euros. This was about 113% of its gross domestic product (GDP). The realization came despite EU warnings to several countries about their excessive debt levels; these were supposed to be capped at 60% of GDP.

If the economy slowed, the countries could have a tough time paying back their debts with interest.

In early 2010, the EU noted several irregularities in Greece's accounting systems. This led to upward revisions of its budget deficits. Rating agencies promptly downgraded the country's debt, which led to similar concerns being voiced about other troubled countries in the eurozone. These countries included Ireland, Italy, Portugal, and Spain.

Each of these had similarly high levels of sovereign debt. If these countries had similar accounting issues, the problem could spread to the rest of the region.

The negative sentiment led investors to demand higher yields on sovereign bonds. This ended up exacerbating the problem by making borrowing costs even higher. Higher yields also led to lower bond prices; this meant larger countries and many eurozone banks holding sovereign bonds began to lose money.

Regulatory requirements for these banks required them to write down these assets. Then, they bolstered their reserve ratios by saving more than lending. This put a strain on liquidity.

How Did the Rescue Package Work?

After a modest bailout by the International Monetary Fund, eurozone leaders agreed on a 750 billion euro rescue package. They also established the European Financial Stability Facility (EFSF) in May 2010. Eventually, this fund was increased to about 1 trillion euros in February of 2012. Several other measures were implemented to stem the crisis as well.

Note

Rescue measures were highly criticized and unpopular in some nations such as Germany. These countries have larger and more successful economies.

Countries receiving EFSF bailout funds were required to undergo harsh austerity measures. These were designed to bring their budget deficits and government debt levels under control by reducing spending. Ultimately, this led to popular protests throughout 2010, 2011, and 2012. These culminated in the election of anti-bailout socialist leaders in France and Greece.

What Were Potential Solutions to the Crisis?

The Eurozone Crisis was dealt with using bailouts, quantitative easing, and lower interest rates. Rich countries like Germany initially supported austerity measures designed to bring down debt levels.

In contrast, poorer countries facing financial problems complained that austerity only hindered economic growth prospects further. It also eliminated any possibility of "growing out" of the problem through economic improvement.

The so-called Eurobond was proposed as a radical solution. It was a security that would be jointly underwritten by all eurozone member states. These bonds would presumably have traded with a low yield; they would have enabled countries to more efficiently finance their way out of trouble. They also would have eliminated the need for additional expensive bailouts. 

Some experts also believed that access to low-interest debt financing would eliminate the need for countries to undergo austerity and only push back an inevitable day of reckoning. The debate over how to deal with further eurozone financial crises continues.