Eurozone crisis

In addition to the following text, this article comprises:      - a country-by-country summary of the development of the crisis;      - links to contemporary reports of the main events of the crisis;      - notes on the debt trap, the eurozone's departures from optimum currency area criteria, and on the eurobond proposal; and,      - tabulations of the fiscal characteristics of the PIIGS countries , 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. According to the Commission services 2011 Spring forecasts, the government deficit exceeded 3% of GDP in twenty-two Member States in 2010.

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 announced its intention to make secondary market purchases of private and European government bonds under 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 with volume of up to €60 billion. Activation was to be on a joint EU/IMF basis and on terms similar to those used by the IMF. In addition, eurozone governments agreed to provide pro rata assistance of up to up to €440 billion over 3 years.

The European Stability Mechanism

In 2011 it was decided to set up a permanent European Stability Mechanism. It was not intended to be used to take on a country's debt, but only to tide it over until it decame able to finance its debt on the financial market. Assistance would be subject to assessments of the country's short-term liquidity needs, and of its fiscal sustainability. The enabling treaty was signed by the 17 euro area member states in July 2011 and the mechanism is due to begin operating in 2013.

The PIIGS

The economies of five of the eurozone countries (Portugal, Italy, Ireland, Greece and Spain) differed in several respects from those of the others. Unlike most of the others, they had developed deficits on their balance of payments current accounts (largely attributable to the effect of the euro's exchange rate upon the competiveness of their exports). Deleveraging of corporate and household debt had amplified the effects of the recession to a greater extent - especially in those with larger-than-average financial sectors, and those that had experienced debt-financed housing booms. In common with the others, they had developed cyclical deficits under the action of their economies' automatic stabilisers and of their governments' discretionary fiscal stimuli, and increases in existing structural deficits as a result of losses of revenue-generating productive capacity. In some cases, their budget deficits had been further increased by subventions and guarantees to distressed banks. The principal factor that set them all apart from their eurozone partners was, however, the attitude of bond market operators. To compensate for concerns about their fiscal stability, those operators were adding risk premiums to the interest rates that the governments of the PIIGs countries had to offer in order to roll-over maturing debt.

The development of a crisis

A chronology of the crisis, with links to contemporary reports, is available on the timelines subpage and a country-by-country account of the crisis is availabe on the addendum subpage.

In 2009, the Greek goverment faced the prospect of being unable to fund its maturing debts, and in 2010 the Irish government found itself in a similar position. Their problems arose from large increases in their sovereign spreads reflecting the bond market's fears that they might default - fears that were based upon both their large budget deficits, and their limited economic prospects. In May 2009, the Greek government was granted a €110 billion rescue package, and in November 2010 the Irish government was granted an €85 billion rescue package, both financed jointly by the eurozone governments and the IMF. Further increases in spreads showed that the rescue packages had failed to reassure the markets. Further support packages also failed to solve the problem, and signs began to appear of the contagion of the bond market fears from Greece to other eurozone countries, particularly Portugal and Spain. What had started as a Greek crisis was developing into a eurozone crisis because the rescue packages that could be needed for the much bigger economies of Spain or Italy were expected be larger than the eurozone could afford. It was also acquiring the potential to trigger a second international financial crisis because the default of a European government might be expected to create a shock comparable to the failure of the Lehman Brothers bank that had triggered the crash of 2008.