The Particularity Study of Eurozone Debt Crisis

Influenced by the earlier 2007 financial crisis that originated in the USA housing market, the subsequent eurozone crisis happened in 2009 in Greece and then spread to Spain, Italy, Cyprus, and other eurozone counties, triggering the European debt crisis. However, external aid and internal austerity efforts of debtor counties have not achieved satisfactory results and failed to fundamentally solve the crisis. The continuous evolution of the European sovereign debt crisis has become a key issue troubling the economic recovery of the entire EU. The particularity study of the past and the potential future debt crisis in the eurozone is necessary.

Interdependence of fiscal and monetary policy

The sovereign debt crisis has posed challenges to monetary policy. In the Eurozone, the attempt to keep a central monetary authority (together with its associated national central banks) independent from 17 diverse fiscal authorities was flawed.

Many articles and journals have focused on the close connection between fiscal and monetary policy. The relationship between monetary and fiscal authorities can be of two alternative types. The first is one of “dependence” – typically of the monetary authority on the fiscal authority. The second type is a relation of “mutual independence” with a well-defined monetary policy mandate. The literature has shown that countries displaying more independent central banks also enjoyed lower average inflation rates. However, in the case of the eurozone crisis, this set-up would not be able to deliver price stability and growth, as the rules for fiscal authorities are not compellable.

The institutional design of the euro highlights the restriction of unified monetary policy and decentralized fiscal policy but ignored the mutual cooperation between the two. The eurozone member states have no power to issue money, which means losing state currency sovereignty. As a result, without the interest rates and exchange rates as macroeconomic adjustment levers, the member states can only rely on fiscal expansion and borrowing foreign debt to solve their unemployment and income problem.

In addition, the bonds of these member countries will also become the object of speculation in the international market. By this time, member states have already breached the stability and development fact, which limits fiscal deficits to 3% of GDP and sovereign debt to 60% of GDP. It became so detached from the level of economic development and the country’s ability to pay its debts that investors’ trust in government bonds fell to zero, triggering further chain reactions.

The undertaker of quantitative easing (QE)

Europe did not start recovering until 2015, while the place where the crisis had originated, the USA, has avoided the second recession and continued its recovery much fast than Europe. The actions form ECB and Federal Reserve in the case of a crisis occurring can be compared to gain further understanding of the case.

Both central banks have chosen similar procedures in reaction to the crisis, lowering interest rates and injecting liquidity. Nevertheless, they differed largely in how far and when they applied these procedures. Just before the first outbreak in Greece by the end of the year 2008, interest rates in the USA were almost 0%. The Federal Reserve already engaged effectively in quantitative easing (QE), eventually buying trillions of dollars of government bonds and mortgage-backed securities. Meanwhile, it took Europe almost five months to reduce its interest rate all the way down from 2.5% to 1%. The historically low-interest rates have ECB troubled, as they driven interest rates up again in 2011 to 2.5%.

The condition for the Euro started to get better as the second recession-hit Europe, forced the new president of ECB Mario Draghi to lower interest rates down to 0% and promised to put a QE plan after tough negotiations. Nevertheless, ECB came too late to rescue the eurozone form its second recession in 2012, causing some irrecoverable damages to the eurozone system. Even nowadays, the interest rates remain at a relatively low figure, monetary policy is far from normal with no space for decreases to stimulate the economy if a crisis happens again. Although the ECB could do more QE to release the pressure, it will most likely counter opposition from other counties.

Silent bailout system (Target2 )

The more recent concern in the eurozone was raised by Italy’s participation. Italy as a major deficit country in the eurozone, in this case, has a net debt of 132% of its GDP. While Greece was ‘small’ enough for core countries of the eurozone like Germany to rescue. Italy is too big to fail and too big to save, causing the panic that Italy is pushing Europe to the brink of another economic crisis.

The large size of government borrowing in debtor counties has caused borrowing more difficult to proceed. The ordinary procedure for borrowing involves the government in selling bonds which could be bought by foreign banks. However, the institutions are becoming wary about the indebted counties that might experience a default. Therefore, the eurozone’s Target2 system acts as a clearing system for ECB. Funds are transferred through Target2 when a euro zone country needs to make a payment to another country. Where NCB are allowed to accumulate debt without any requirement to repay.

The underlying problem is that after the previous financial crisis, the economic balance within the eurozone is damaged, the time when the majority of the payments between eurozone counties being offsetting has passed. Furthermore, the different business cycles in the eurozone, along with poor labor and capital market flexibility, mean systematic trade surpluses and deficits will build up, because inter-regional exchange rates can no longer be changed.

Italy as one of those deficit counties, has been using Target2 precisely to let large surplus areas to recycle their surplus back to deficit areas via transfers to keep eurozone economies in balance. Target2 has become a fancy “credit card” with no interest rate and the loan never needs to be repaid. By June 2018, the Target2 debt of the Bank of Italy (BoI) has reached €481bn. To even further worsen the situation, Target2 is also being used to facilitate capital flight, as the government’s fiscal deficit in some eurozone counties has increased to a certain level that citizens have lost faith in their banking system.

As the ECB mentioned the importance of Target2 as a “normal feature of the decentralized implementation of monetary policy in the euro area”. Target2 cannot play the role as a long-term solution to systemic Eurozone trade imbalances and weakening national banking systems.

Final thoughts and opinions

Although being a bit more sluggish, the Eurozone did stretch its command and risked compromising its independence in order to keep EMU (Economic and Monetary Union of the European Union) intact. For Europe to further smooth out the crisis, directing the right amount of provision of liquidity to the regions that needed the most is crucial. This could also help to reduce the fragmentation in bank intermediation, improving the growth rate and providing more tranquillity for deficit counties in the eurozone. Enabling the EMU’s future expectation of allowing an optimum currency region to proceed.


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  2. Blake, D. (2018). The silent bailout system that could rip the eurozone apart. [online] Available at: [Accessed 14 Mar. 2019].
  3. Cukierman, A. (1992), Central Bank Strategy, Credibility, and Independence: Theory and Evidence, The MIT Press.
  4. Goodhart, C. (2014). Lessons for Monetary Policy from the Euro-Area Crisis. Journal of Macroeconomics, 39, pp.378-382.
  5. Harvard Business Review. (2018). What Has the Eurozone Learned from the Financial Crisis?. [online] Available at: [Accessed 12 Mar. 2019].
  6. Steele, G. (2013). The UK and the Eurozone: Sovereign Debt Management and Monetary Policy. Economic Affairs, 33(3), pp.327-333.
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  8. Whittaker, J. (2016). Eurosystem Debts Do Matter. SSRN Electronic Journal.
29 April 2022
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