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The Eurozone Crisis Explained

By Disha Sachdeva

Edited by Anandita Malhotra, Senior Editor, The Indian Economist

The currency Euro began in 1999 with 11 member countries (there are now 18). The world, and Europe in particular, was full of high expectations for the it at that time. Euro members gave control of monetary policy to the European Central Bank (ECB) which sets interest rates for the whole of the Eurozone. It seemed that the European Union, had taken a bold step toward greater integration, and a much-enhanced competitive posture vis a vis the USA. Some even argued that the euro bloc would soon overtake the United States in economic clout.

It did not turn out that way.

 Several European countries lost control of their finances due to the recession caused by the 2008 crisis as well as a lack of strong fiscal reforms. They kept on slipping further and further into debt and eventually, were unable to find lenders due to their inability to pay back the borrowed money. This resulted in the Sovereign Eurozone Debt Crisis.


  • 2008 Financial Crisis

 Due to the bursting of the housing bubble, major big banks in the US suffered massive losses. Lehman Brothers shut down as it was completely ruined by the amount of bad loans it had accumulated. Banks in Europe did business with such banks daily. In the aftermath, banks and investors became extremely risk averse causing lending and investments to plummet. Respective governments aided these banks and in the process negatively affected their own finances. In Ireland, the bailout almost bankrupted the government and financial assistance from other countries had to be provided.

  • One Common Monetary Policy

European Central Bank (ECB) set interest rates for the whole of the Eurozone instead of customizing it for different countries as per their requirement. Some large countries, such as Germany, had weak growth and this led to the ECB setting a relatively low interest rate for the entire Eurozone. However, this rate was too low for some booming economies like Ireland and Spain and helped create large housing market bubbles there. Borrowing costs for all Eurozone governments converged upon the euro’s creation, meaning countries were now able to borrow more cheaply. Hence, they started to spend more. This fuelled a buildup of government debt in Greece and Portugal, as well as private sector debt in Portugal, Ireland and Spain. The financial markets started perceiving every country in the Eurozone to have virtually the same risk of defaulting on their loans.

  • Rating Agencies

They did not reduce the ratings of various American Banks even during the formation of the housing bubble but once the crisis spread to the Eurozone, these agencies quickly downgraded the ratings of various European countries significantly. This meant that new loans could only be provided at higher interest rates. It started a vicious cycle of borrowings, high interest payments and more borrowings.

When one country defaults, it affects the entire Eurozone as the trade and flow of money with other countries stagnates. This caused a slowdown in the entire Eurozone. With economic instability, investors started withdrawing money from problem areas. This caused the flow of money in Eurozone to diminish in sectors such as healthcare, small businesses etc.

In order to correct the situation, governments executed various austerity measures such as higher taxes. This led to a reduction in output and therefore, employment.

The steps to recovery still have a long way to go. According to the Ernst and Young Eurozone Forecast growth is to pick up by 1.2% in 2015 and 1.6% a year in 2016-18. However, there is concern about the Eurozone’s vulnerability, especially because there is a probability of Greece leaving the Zone.

Disha Sachdeva is a 2nd year student pursuing Bachelor of Commerce from Shri Ram College of Commerce. Her biggest fear is that her ‘To Be Read’ list might be longer than her life expectancy. She is a feminist who prefers to hear both sides of a story before forming her opinion. She tries to balance her academics, societies, MBA preparation and attendance together and hopes to be fluent in Dothraki one day!

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