What caused the eurozone crisis, and why do economists still disagree about the cure?
Four countries could no longer pay their debts, and sharing one currency meant they could not devalue their way out. The argument over what to do next is still going.
▶ Start the storyThe eurozone crisis was a debt and financial crisis that ran from 2009 to 2018. Greece, Portugal, Ireland and Cyprus could no longer manage their debts or bail out their banks, and they needed help from other eurozone countries, the ECB and the IMF. It began in late 2009 when Greece disclosed that its budget deficits were far higher than previously thought, and Greece got an EU-IMF in May 2010.
There is a consensus on the root cause: a sudden stop of foreign capital into countries that depended on foreign lending, made worse because states that share the euro cannot devalue their currency to make exports cheaper. The ECB's interest rate also made it attractive for northern investors to lend to the south, and for the south to borrow, building up deficits there.
The human cost was high: , unemployment as high as 27% in Greece and Spain, and more poverty and inequality.
The cure is where views divide. Economist Paul Krugman argued that would prolong and deepen recessions, while policy makers such as EU commissioner Olli Rehn and most European finance ministers believed budget consolidation would revive confidence. In October 2012 the IMF said its forecasts for austerity countries had been consistently overoptimistic.
Critics, e.g. Paul Krugman
- Predicted cuts would prolong and deepen recessions
- Over 9,000 signatories of a manifesto joined him
- The IMF later said its forecasts were overoptimistic
Policy makers, e.g. Olli Rehn
- Most European finance ministers shared the belief
- Held that budget consolidation revives market confidence
- Expected the effect to show over the longer haul
The turning point came in 2012, when ECB president Mario Draghi pledged to do whatever it takes to preserve the euro. Ireland and Portugal left their programmes in July 2014.
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Recap
Capital stopped flowing, countries could not devalue, rescues came with austerity, and economists still argue whether the cure was right.
💡 A trick to remember it · Picture a group tied together by one belt: when one stumbles, they can't loosen their own notch, so everyone argues about who pulls whom up.
Surprising fact · In 2012 the ECB president promised to do whatever it takes, and the sole Governing Council member who voted against the follow-up plan was Bundesbank chief Jens Weidmann.
Sources (2)
No source, no claim. Every fact in this lesson (16 claims) cites at least one of these.