The Spanish Financial Crisis: Causes, Effects, and Austerity Measures

The Spanish Financial Crisis

Ley del Suelo

The Spanish financial crisis began as an extension of the international financial crisis of 2008, but internal imbalances accumulated in the pre-crisis period aggravated the situation.

Causes of the Crisis

The main cause of Spain's crisis was the housing bubble and the accompanying unsustainably high GDP growth rate. The ballooning tax revenues from the booming property investment and construction sectors kept the Spanish government's revenue in surplus, despite strong increases in expenditure, until 2007. The rapid economic growth encouraged a boom in property. In 2006, Spain started building 800,000 new homes – more than Germany, Italy, France, and the UK combined.

However, in 2008, Spain was badly affected by the global credit crisis. The Spanish property market collapsed, leading to a deep recession that persisted for several years.

Factors Contributing to the Recession

Since 2008, Spain has seen a sharp fall in GDP due to a combination of:

• Overvalued exports
• EU recession
• Austerity policies (government spending cuts)
• Collapse in the property market and banking crisis

Current Account Deficits in the Eurozone

Spain is a member of the Euro. However, over the past few years, Spain has seen a relative decline in competitiveness compared to the Eurozone average. This has made Spanish exports more expensive. Spain’s current account deficit has fallen to 5% of GDP, but this partly reflects a sharp drop in consumer spending on imports.

Unemployment

Spain has experienced high levels of unemployment since the crisis began.

Spanish Bond Yields

Due to rising government debt, markets became worried about the Spanish government’s ability to repay the debt. In 2012, Spanish bond yields were hovering just below the critical 7% level.

One of the main reasons for the Spanish government debt crisis is the banking crisis, which has put pressure on the government to bail out Spanish banks.

Like other Eurozone economies, Spain had no ability to devalue or print money. Therefore, markets feared a liquidity crisis, and this pushed up bond yields.

Austerity Measures

In response to rising bond yields and the need to bail out banks, under pressure from the EU, Spain began a series of austerity measures aimed at reducing the budget deficit and reducing the high bond yields.

Unfortunately, the austerity measures contributed to a rise in unemployment and a further double-dip recession. The scale of the government cuts, bank bailouts, and wage freezes led to social unrest and protests in major Spanish cities.

Also, austerity measures have not succeeded in reassuring markets. Despite several austerity measures, Spanish bond yields remain very high. Also, the budget deficit has shrunk by a smaller amount than expected. The debt-to-GDP ratio has been difficult to reduce because nominal GDP is falling.

Public Debt

Spain entered the crisis period with a relatively modest public debt of 36.2% of GDP. This was largely due to ballooning tax revenue from the housing bubble, which helped accommodate a decade of increased government spending without debt accumulation. In response to the crisis, Spain initiated an austerity program consisting primarily of tax increases.