The Eurozone Economic Crisis and Its Global Impact

The Euro Crisis

The global economy has experienced slow growth since the U.S. financial crisis of 2008-2009, which has exposed the unsustainable fiscal policies of countries in Europe and around the globe. Greece, which spent heartily for years and failed to undertake fiscal reforms, was one of the first to feel the pinch of weaker growth. When growth slows, so do tax revenues—making high budget deficits unsustainable.

In 2007, EU economies, on the surface, seemed to be doing relatively well—with positive economic growth and low inflation. Public debt was often high, but (apart from Greece) it appeared to be manageable assuming a positive trend in economic growth.

Impact of the Global Credit Crunch

However, the global credit crunch changed many things:

• Bank Losses: During the credit crunch, many commercial European banks lost money on their exposure to bad debts in the US (e.g., subprime mortgage debt bundles).
• Recession: The credit crunch caused a fall in bank lending and investment; this caused a serious recession (economic downturn).
• Fall in House Prices: The recession and credit crunch also led to a fall in European house prices, which increased the losses of many European banks.

Recession and Rising Government Debt

The recession caused a steep deterioration in government finances. When there is negative growth, the government receives less tax: fewer people working results in less income tax; fewer people spending results in less VAT; and lower company profits result in less corporation tax, etc.

Eurozone Bond Yields

Markets had assumed Eurozone debt was safe. Investors assumed that with the backing of all Eurozone members, there was an implicit guarantee that all Eurozone debt would be safe and had no risk of default. Therefore, investors were willing to hold debt at low interest rates even though some countries had quite high debt levels.

Eurozone countries with debt problems are also generally uncompetitive, with a higher inflation rate and higher labor costs. This means there is less demand for their exports, a higher current account deficit, and lower economic growth.

Key Problems Facing the European Union

• High unemployment
• Stagnant economic growth and the chance of a prolonged recession
• Very large current account deficit due to a loss of competitiveness
• High government borrowing and higher interest rates on government bonds because of fears over default