Eurozone crisis

In addition to the following text, this article comprises links to contemporary reports of the main events of the crisis; and notes on the the financial status of the PIIGS, their notionally required sustainability adjustments and their GDP growth rates

The financial assistance that was provided to the governments of Greece and Ireland in 2010 did not restore the confidence of the markets in their continued ability to service their debt, and bond market investors became reluctant to buy the bonds being issued by some other eurozone governments. The eurozone crisis that started in 2010 arose from doubts about the willingness of major eurozone governments to provide the further assistance that may be needed, and fears that there may be a breakup of the eurozone if they do not.

Overview

During 2010, prospective investors became increasingly reluctant to buy the bonds issued by five eurozone governments (Portugal, Ireland, Italy, Greece and Spain) at the offered interest rates, and the governments concerned had to make a succession of increases in those rates. Two of those governments - Greece and Ireland - eventually decided that, without help, they would not be able to continue to finance their budget deficits, and they sought - and received - loans from other European governments. Those loans failed to reassure potential investors, and in November they demanded further increases in the interest rates on the government bonds of all five governments (including those of Portugal, Spain and Italy, because of fears of contagion from Greece and Ireland).

By December 2010, there was widespread uncertainty about future prospects for the eurozone and beyond. There were doubts about the willingness of European governments to provide further financial support to the five "PIIGS" governments, and speculation that financing difficulties might spread to affect other governments. Some commentators considered it inevitable that one or other of the PIIGS governments would default on its loans, and other commentators forecast departures from the eurozone by governments wishing to escape its restraints. There were even those who envisaged wholesale departures, leading to a collapse of the common currency - an outcome that would impose substantial losses upon countries with investments in euro-denominated securities, and could threaten the stability of the international financial system.

Background to the crisis

The eurozone

Membership

In 1991, the 15 members of the European Union, meeting in the Dutch town of Maastricht, agreed to set up a monetary union with a single currency. They agreed upon strict criteria for joining, including targets for inflation, interest rates and budget deficits, and they subsequently agreed upon rules of conduct that were intended to preserve its members' fiscal sustainability. No provision was made for the expulsion of countries that did not comply with its rules, nor for the voluntary departure of those who no longer wished to, but the intention was announced of imposing financial penalties for breaches.

Greece joined the eurozone in 2001, Slovenia in 2007, Cyprus and Malta in 2008, Slovakia in 2009. The current membership comprises Belgium, Germany¸ Ireland, Greece, Spain, France, Italy, Cyprus, Luxembourg, Malta, The Netherlands, Austria, Portugal, Slovenia, Slovakia, and Finland. Bulgaria, Czech Republic, Denmark, Estonia, Latvia, Lithuania, Hungary, Poland, Romania, Sweden and the United Kingdom are EU Member States but are not members of the eurozone.

The Stability and Growth Pact

The Stability and Growth Pact that was introduced as part of the Maastricht Treaty in 1992, set arbitrary limits upon member countries' budget deficits and levels of national debt at 3 per cent and 60 per cent of gdp respectively.

Following multiple breaches of those limits by France and Germany, the pact has since been renegotiated to introduce the flexibility necessary to take account of changing economic conditions. Revisions introduced in 2005 relaxed the pact's enforcement procedures by introducing "medium-term budgetary objectives" that are differentiated across countries and can be revised when a major structural reform is implemented; and by providing for abrogation of the procedures during periods of low or negative economic growth . A clarification of the concepts and methods of calculation involved was issued by the European Union's The Economic and Financial Affairs Council in November 2009 which includes an explanation of its excessive deficit procedure.

The bail-out clauses

Article 104 of the Maastricht treaty appears to forbid any financial bail-out of member governments, but article 103 of the treaty appears to envisage circumstances under which a bail-out is permitted,

Bond purchase programme

In July 2009 the European Central Bank launched a "covered bond purchase programme", under which national central banks and the European Central Bank would buy eligible covered bonds . The aim of the programme was to support those financial market institutions that supply funds to banks that had been particularly affected by the financial crisis. The purchases under the programme were for a nominal value of EUR 60 billion. Its completion was announced on 30th June 2010, but there were reports of continued small-scale purchases in subsequent months. On 10th May 2010 the European Central Bank renewed purchases with its Securities Markets Programme . All purchases are sterilised in order not to affect the money supply

The Financial Stability Facility

In May 2010, the European Council adopted a regulation establishing a European financial stabilisation mechanism. A volume of up to EUR 60 billion is foreseen and activation is subject to strong conditionality, in the context of a joint EU/IMF support, and will be on terms and conditions similar to the IMF. The mechanism will operate without prejudice to the existing facility providing medium term financial assistance for non-euro area Member States' balance of payments. In addition, the representatives of the governments of the euro area member states adopted a decision to commit to provide assistance through a Special Purpose Vehicle that is guaranteed on a pro rata basis by participating member states in a coordinated manner and that will expire after three years, up to EUR 440 billion, in accordance with their share in the paid-up capital of the European Central Bank and pursuant to their national constitutional requirements

The problem of the PIIGS

Since the inception of the eurozone, five of its members - Portugal, Italy, Ireland, Greece and Spain - had suffered increases in the interest rates payable on their bond issues, reflecting investors' fears that they might default. Those fears were mainly attributable to recession-induced increases in their budget deficits or in their public debt that raised doubts about their fiscal sustainability. Two of them - Greece and Ireland - have been given financial support, conditional upon their adoption of deficit-reduction programmes. In neither case has that been followed by an improvement in their credit ratings, suggesting that doubts remained concerning their ability to implement those programmes. Their current financial status remained a matter of concern, on their own account and because of the possibility that the bond market's loss of confidence might spread and affect the fiscal stability of Belgium and other EU countries. It was suggested that the future of the eurozone was at stake (even in 2009, before the eurozone crisis had gathered strength, the Managing Director of the International Monetary Fund was warning that "most advanced economies will not accept any more [bailouts]...the political reaction will be very strong, putting some democracies at risk"). If the euro were allowed to collapse, however, it has been estimated that reversion to national currencies would be followed by devaluations that would cost British, French and German banks about €360 billion creating a supply shock comparable to the collapse of the Lehmans Brothers bank that had triggered the Great Recession.

The PIIGS countries differed from most of the other eurozone countries by deficits on their balance of payments current accounts and, (some of them) by above-average levels of household and business sector debt. The effects on them of the Great Recession were amplified by deleveraging of the corporate and household debt, especially in countries with larger-than-average financial sectors, and those that had experienced debt-financed housing booms. Its effects upon their governments' fiscal stance were to create cyclical deficits because of the action of their automatic stabilisers and of discretionary fiscal stimuli, and to increase the previous structural deficits as a result of the loss of revenue-generating productive capacity. In some of the PIIGS countries, budget deficits were further increased by subventions and guarantees to distressed banks.

The development of a crisis

A chronology of the crisis, with links to contemporary reports, is available on the timelines subpage