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Crisis in Euroland: Year in Review

Author: Christopher Alessi
December 12, 2012

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EU leaders took significant, if halting, steps in 2012 to rein in the ongoing eurozone debt crisis and facilitate greater European fiscal and political integration. The European Central Bank's announcement that it was prepared to buy an unlimited amount of government bonds on the secondary market was arguably the most aggressive measure taken this year. The move sent a strong signal to jittery markets that the EU would take any necessary actions to shore up the single currency area, while providing struggling sovereigns with the space to implement vital structural reforms. At the same time, the EU began to slowly lay the groundwork for new pan-European agreements and institutions--including a fiscal compact and banking union--that could make the EU and eurozone more durable, while staving of future crises. Still, many eurozone states face significant challenges in implementing the economic and labor reforms necessary to make their economies more competitive, while reducing their debt and deficit burdens.

ECB President Mario Draghi announced unlimited bond buys in September. Photo: REUTERS/Alex DomanskiECB President Mario Draghi (Photo: Alex Domanski/Courtesy Reuters)

A Second Bailout for Greece

Eurozone leaders agree in late February to a second bailout package for Greece worth $172 billion, including a 53 percent debt write-down by private bondholders. In exchange, Greece vows to implement further austerity measures to help tackle its mounting debt burden. The plan is designed to reduce Greece's debt-to-GDP ratio from 160 percent to 120.5 percent by 2020, but is deemed unrealistic by the middle of the year. Similarly, many policymakers and economists are skeptical that the second bailout will be sufficient, while others worry the attendant austerity measures will only plunge Greece further into recession.

EU Leaders Adopt a Fiscal Compact

In early March, leaders of twenty-five out of the twenty-seven EU countries (all but the United Kingdom and the Czech Republic) sign a new Fiscal Compact treaty mandating stricter budget discipline (BBC). The treaty must be ratified by twelve eurozone states to take effect. The compact was originally developed at an EU summit in December 2011 in an effort by European leaders to facilitate greater fiscal integration, amid mounting fears that the eurozone and wider EU could collapse. However, the treaty faces criticism (ProjectSyndicate) from some policymakers and economists for failing to address the economic plight of indebted eurozone states, while crystalizing a German-driven agenda of austerity amid a deepening eurozone recession.

France Rejects Sarkozy and Austerity

Former French president Nicolas Sarkozy reacts after his defeat. Photo: REUTERS/Yves HermanFormer French president Nicolas Sarkozy (Photo: Yves Herman/Courtesy Reuters)

In May, French voters elect Socialist François Hollande (WSJ) as the new president of France, rejecting, at least rhetorically, Nicolas Sarkozy and his pro-austerity--and pro-German--approach to the eurozone crisis. Hollande vows to challenge German Chancellor Angela Merkel by shifting the policy discourse away from budget cuts and implementing a so-called growth pact. Nonetheless, Hollande is forced to adopt austerity policies and the fiscal compact, while conceding the significant economic challenges confronting France.

Greeks Vote to Stay in the Euro

Greece's center-right New Democracy party wins (CNN) the most votes in a second round of parliamentary elections in June. The victory ensures the country's commitment to EU bailout plans and austerity measures, and staves off a Greek exit from eurozone. The elections come on the heels of a first round of voting in May that yielded significant gains for fringe, anti-austerity parties, calling into question Greece's future in the single currency union. The vote is considered a public endorsement of Greece's EU membership, reassuring markets and political leaders of the country's commitment to the single currency.

Spain Requests Bank Bailout

In June, the Spanish government officially requests "up to a maximum" of $122 billion in EU funds to recapitalize its ailing banks (DerSpiegel) and provide a buffer of capital to prevent future crises. By September, Spanish Prime Minister Mariano Rajoy implements a fresh round of austerity measures amid growing fears the country may need to request a full government bailout from the EU. Meanwhile, the EU approves $48 billion (WSJ) in funds for the Spanish bank rescue in late November. The move signals a widening of the eurozone crisis from one centered on sovereign debt to one with a banking crisis component.

EU Officials Propose a Banking Union

At the end of June, EU leaders introduce plans to create a so-called banking union that would provide a centralized regulatory framework for the eurozone's large banks. In July, EU officials move forward on plans for establishing a banking supervisor that would be situated in the European Central Bank (WSJ). The single EU banking authority would potentially be able to activate the permanent EU rescue fund in order to directly recapitalize struggling eurozone banks, such as those in Spain. The plan is the latest EU initiative to centralize control over eurozone finances while reducing the power of national governments, but raises questions about the role of the ECB and whether it is acquiring too much power without a democratic mandate. However, in mid-December, EU finance ministers officially agree to a deal to create a single banking supervisor (WSJ) within the ECB that will monitor at least one hundred and fifty of the eurozone's biggest banks and those in other EU countries that choose to participate, the first concrete step toward establishing a banking union.

ECB Unveils Unlimited Bond-Buying Plan

In late July, ECB President Mario Draghi vows that the central bank will "do whatever it takes to preserve the euro" (Bloomberg), sending markets higher and reducing borrowing costs for indebted sovereigns. Weeks later, Draghi announces a new and potentially unlimited program to buy government bonds of struggling eurozone states (Reuters) on the secondary market in order to bring down their borrowing costs and calm markets. Draghi says the plan will provide a "fully effective backstop to prevent potentially destructive scenarios," despite objections from the German central bank on grounds that the ECB is overstepping its monetary policy mandate and moving into the sphere of fiscal policy. The bank's actions also underscore concerns over an increasing democratic deficit (FT) in European policymaking.

German Court Supports Bailout Fund

Germany's Constitutional Court approves the eurozone's new rescue fund. Photo: REUTERS/Kai Pfaffenbach Germany's constitutional court (Photo: Kai Pfaffenbach/Courtesy Reuters)

Germany's constitutional court in September approves the establishment of the eurozone's €500 billion ($650 billion) permanent rescue fund, the European Stability Mechanism (FT), paving the way for it to be fully operational by the end of 2012. The ESM is inaugurated (DuetscheWelle) by eurozone finance ministers in early October in Brussels, amid a debate over exactly what role the fund will play in alleviating the continent's debt crisis. Activist groups in Germany had filed a lawsuit over the constitutionality of the bailout fund (DerSpiegel). While the challenge was overturned, the case crystalized both the frustration about the lack of democratic accountability at the European level and increasing public opposition to paying for the indebted eurozone periphery.

A Revised EU Aid Deal for Greece

In November, eurozone finance ministers and the International Monetary Fund agree to a revised aid deal for Greece (DerSpiegel), including lowering interest rates on Greek bailout loans and implementing a debt-buyback program. The new plan requires Greece to cut its debt-to-GDP ratio to 124 percent by 2020, rather than 120 percent, while committing to bring its debt levels "substantially below" 110 percent by 2022. The deal also allows for the release of the next tranche of bailout money (FT) for Greece in December, totaling around €34 billion.

Not Out of the Woods Yet

Despite the substantial steps taken by EU policymakers over the past year, many challenges lie ahead for the beleaguered monetary union. The Roubini Group's Megan Greene writes that, "While the most disastrous possible risk – a complete, disorderly disintegration of the eurozone – has been greatly reduced by the ECB's new bond-buying program … the worst of the eurozone crisis is by no means behind us." If the eurozone moves forward with further fiscal and political integration, it could marginalize countries in the EU that do not use the euro, creating a so-called two-tier Europe. At the same time, the United Kingdom continues to distance itself from the EU, which could ultimately result in a British exit and a complete rethinking of the union. More broadly, the eurozone's larger economies like Italy and Spain--and, perhaps, most notably France (Economist)--have substantial structural reforms to undertake to make their labor markets more flexible and economies more competitive in order to avoid being dragged further into the mire of sovereign debt that has consumed the periphery.

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