The European debt crisis started in 2008 when many European countries were not able to refinance their government debt or bail out over-indebted banks of their country without the supervision of third parties like the European central bank (ECB), other countries and the International Monetary Fund (IMF). Portugal, Italy, Ireland, Greece and Spain had to some degree failed to generate enough economic growth to pay off bondholders.
There were many reasons behind why the European debt crisis occurred. One of the main reasons was because of the common currency of Europe, the Euro.
Every member of the EU shared the Euro and also had similar monetary policies. But each country had control over its own fiscal policies that decided government borrowing and spending. Because of this, countries like Portugal and Greece kept borrowing and spending and soon, it went out of control. Large amounts of debt began to build up. This was the structural problem of having a common currency for multiple countries but not having rules on forming their respective fiscal policies.
The second cause was the Global Financial Crisis in 2008. Because of this, Industrial production fell and financial institutions plummeted. This discouraged investors. The cost of borrowing also increased as investors demanded more interest. Hence, Greece struggled to keep up as they relied heavily on debt. Their GDP decreased by almost 7% and output fell by 16%.
Third, strict restrictions slowed economic growth. Unemployment was increased, consumer spending was reduced and also reduced lending capital. There were also no penalties for violating debt to GDP ratios that were set up by the EU. This was because it was believed that the only penalty possible was exclusion from the EU and this would lead to a fall in the value of the Euro itself.
Another cause was the increasing central government debt and the high cost of borrowing coupled with the failing financial system. Greece’s debt became 113% of their total GDP and needed countries like Germany to bail them out and pay their creditors. Soon, Spain, Ireland and Portugal also needed bailouts.
Lastly, many of the EU countries had large trade imbalances which contributed heavily to the crisis as a whole. Germany was the only country with a good debt and fiscal deficit situation. Countries like Italy, Spain and Portugal had a large fiscal deficit and an even worse balance of payment position. Some countries went to the World Bank and International Monetary Fund for assistance as they were very financially stable. Amidst all this, the Euro was devalued to boost exports in hopes of helping economic recovery. However, what this did was worsen the debt situation as it increased the dollar value of the existing debt.
Eduindex News 