The European Dept Crisis. Why it occured and what we can learn of it

Bachelor Thesis, 2019

23 Pages, Grade: 7.5



Chapter 1: Introductio
1.1 Institutional design ofthe European monetary union

Chapter2: Development ofthe EMU 1999-2
2.1 Macroeconomicdifferences
2.2 Current account imbalances
2.3 Private and public debt development 1999-2007

Chapter 3: Real estate bubb

Chapter 4: Banking bubble and the resulting financial crisi
5.1 Private and Public debt development 2007-2018

Chapter6: Conclusion ofthe Root Cause Analys
6.1 Future Research

Works Cit

List ofabbreviations

Abbildung in dieser Leseprobe nicht enthalten

Chapter 1: Introduction

The Euro celebrated its 20th anniversary last year (2019) and is known worldwide as a symbol of the unity and sovereignty of the European Union. Introduced at a time by people and states who had fought a relentless war against each other in the same century, the Euro is one of the greatest achievements of modern times. Today, a European generation is growing up that no longer knows any national currency and does not understand why it is so important to protect the Euro as a common currency. However, it is precisely this generation that has to deal with the national debt crisis, which has become one of the greatest economic policy challenges that the united Europe has faced since the existence of the monetary union.

The purpose of this thesis is to help understand the development of the European sovereign debt crisis from the introduction of the Euro to the present day. In this context, special attention is paid to the analysis of the causes, since these must be understood fundamentally in order to avoid the repetition of the same process in the future. The key motivation behind this paper is that with current declines in economic growth and inverse yield curves pointing towards a recession, it is more important than ever to understand past developments to avoid such collapses in the future. Past empirical research often overlooks this important forward-looking function; further, most works were published immediately after the financial crisis, with relatively few recent contributions. Clearly, the relevance for society as a whole is given, as implications of economic crises as extremely widespread and caused devastation for many. As globalization has only increased in the decade thereafter, any coming recession would be worse than those experienced before.

This thesis can be divided thematically into three major areas, to ultimately answer the questions of how the European debt crisis came to be, what weaknesses within the EMU led to this, and what lessons can be drawn from it all. First, the developments of the EMU from its inception up to the financial crisis in 2007. Second, the financial crisis and its direct impact on the European sovereign debt crisis. Third, the thesis gives an outlook on the current situation eight years after the outbreak of the crisis and provides suggestions for future research. It should be noted that this thesis deals with the main features of the development of the public debt crisis and that an analysis of any and all factors involved goes beyond the scope of the thesis. During the empirical investigation the focus is on the seven key countries of the Euro area. These include the four largest European economies and the countries most affected by the Euro crisis: France, Germany, Italy and Spain, as well as Portugal, Greece and Ireland.

1.1 Institutional design ofthe European monetary union

The monetary integration in Europe started with the launch of the Euro, the single currency of the European Union. The Euro was adopted on 1 January 1999 byllof the 15 Member States of the Union and was a well-prepared and long-awaited moment in the history of Europe. The introduction of the Euro on the financial markets started on 1 January 1999 and the circulation of notes and coins in 2002.

The Maastricht Treaty of 1991 established the conditions for the monetary union. National governments were required to make serious restructuring of public finance and government spending. Restrictive national monetary policies and an independent central bank were meant to promote European integration. In addition, the Maastricht convergence criteria were established; created to ensure an optimal functioning of the monetary union and for all members to work towards an economically heterogeneous community, the criteria included the stability of long-term interest rates, price levels, exchange rates and public finances (Consolidated version of the treaty of the functioning of the European union, 2012).

Proposed by the German government in 1995, the SGP, designed to ensure that countries also adhere to financial discipline in the EMU after accession, was implemented. The SGP offered a set of fiscal rules intended to prevent countries of the EMU from spending beyond their means. A state’s budget deficit was not allowed to exceed 3% of GDP, with national debt at a maximum of 60% of GDP. Failure to abide by these rules are punished with fines up to 0.5% of the GDP (Maria Green Cowles and Michael Smith, 2000).

Chapter 2: Development ofthe EMU 1999-2007

The following analysis deals with the economic development of the European Monetary Union from its formation in 1999 until the financial crisis of 2007. First, the macroeconomic differences between the northern and southern economies are presented. Second, the reasons for the emergence of current account imbalance between different countries are reviewed. Third, the development of the public and private debt is examined. Last, the emergence and reasons for the housing and banking bubble are discussed.

2.1 Macroeconomic differences

Figure 1. Percentage of GDP composed ofExports for Selected European Economies

Abbildung in dieser Leseprobe nicht enthalten

Figure 1 shows the percentage of the GDP made up by Exports between 1999 and 2007.

It can be observed that the economies of northern countries such as Germany and Ireland receive a larger share of their GDP from exports, compared to southern European economies such as Portugal, Spain and Italy, which gain only a small percentage of their GDP from exports with all of them below the EMU average. This suggests that the respective countries have different economic approaches with specific national differences. While Germany is pursuing an export-oriented growth model, countries like Spain or Italy following a demand-oriented growth model (Peter A. Hall, 2014).

Export-oriented countries are focused on enhancing international competitiveness, with strategies including wage-setting by collective bargaining, large investments in education and employment, and well-established inter-company relations that are beneficial to research and innovation. These countries pursue strategies based on export-led growth, that is productivity growth of export goods is greater than the proportional wage growth and domestic demand.

Demand-driven countries, however, are less effective at increasing global competitiveness. Trade unions are strong, but they compete for the right to represent workers and are not in a position to coordinate wage levels (Bob Hancke, 2013). Demand growth strategies are based on expansion of domestic demand and their focus is the employment for the service sector and a low skilled workforce. Low-cost labour often provides the competitive advantage for companies in these countries. As demand growth macroeconomic policies are prone to increase inflation rates, an often-used tool by these governments was the periodic devaluation of their exchange rates to lower export prices and make imports more expensive, thereby offsetting the impact of inflation on the trade balance (Peter A. Hall, 2014).

Considering this diversity of economies within EMU, the ECB faced a problem, as it was responsible for a monetary policy that was appropriate and suitable for the entire union.

From 1999-2006, the ECB engaged in a policy of low interest rates designed to stimulate demand, credit growth, and housing markets in the northern economies (European Parliament, 2019). This low-inflation approach favoured the northern economies, which were able to pursue their export-oriented growth strategies and further enhance their exports. Trading partners within the EMU were not able to depreciate their currency anymore which further strengthened the trade position of the export economies. Subsequently, northern export economies started building up current account surpluses.

Southern economies, however, encountered serious challenges. GIPS countries experienced atypically high growth and inflation rates compared with its European partners, resulting in low or even negative real interest rates from 2000. In this environment people are incentivized to spend cash, rather than to save it at the bank and incur a guaranteed loss. Consequently, investment and consumption are boosted, as is aggregate demand, which in turn may lead to even higher inflation rates. Countries with higher-than-average inflation rates experience an increase in price levels that is too rapid, and they therefore suffer a loss in price competitiveness, while countries with relatively low inflation rates gain in price competitiveness. Hence, export demand tends to decline in countries with higher inflation rates and domestic producers lose domestic market share due to less competitive prices (Jakob de Haan, Marco Hoeberichts, Renske Maas and Federica Teppa, 2016).

2.2 Current account imbalances

Whereas in the past inflationary countries would have simply devalued their currency to restore their competitiveness, this was no longer possible in the EMU. As a result, inflation stayed high, the countries’ exports became uncompetitive, and domestic demand was rising. In addition, there was a capital flow from export-led countries to countries with strong domestic demand. Countries like Germany started to invest their payment surpluses into the GIPS countries, thus floating the countries with cheap credits and overall reducing the cost of capital. These new credits exaggerated the expansion in southern economies and with it the inflation. The ECB was now confronted with a choice, as it “could have used its monetary instruments to reduce rates of inflation in southern Europe but doing so would have risked contraction in the north” (Hall 2014, p. 1228). The ECB opted for a policy that ensured monetary stability in the northern countries but increased inflation in the southern countries.

Figure 2. Overview of Current Account Balance as Share of GDP

Abbildung in dieser Leseprobe nicht enthalten

Figure 2 shows the significant differences between Germany, which follows an export-led economy, and the GIPS countries that pursue a domestic demand model. While Germany still had a slight deficit at the introduction of the EMU, its current account balance as a percentage of GDP rose sharply in the following years and reached its highest point in 2007 at almost 7% of GDP. On the other hand, countries such as Spain, Greece or Ireland, recorded a steady current account deficit ever sincejoining the EMU.

Yet, differences in the current account balance do not always have to be seen as a bad sign. Capital flows from abroad can be used to boost the economy and finance long-term investments. For the most part, however, these loans in the GIPS countries were not used for investments, where the income from such investments could later be used to pay interest and repay principal, but for private consumption and the purchase of real estate (Renate Neubäumer, 2011). The consequence was an accumulation of debt in the GIPS countries.

2.3 Private and public debt development 1999-2007

While the high debt levels of the countries prior to the monetary union would have caused high yields on government bonds, the introduction of a monetary union led to a strong convergence of interest rates.

Figure 3. Overview oflnterest Rates on 10-year state bonds in the EMU

Abbildung in dieser Leseprobe nicht enthalten

(Bill Lucarelli, 2013)

Figure 3 illustrates the convergence of the interest rates that has taken place within the monetary union. It can be seen that before 1999, and thus before the EMU, interest rates differed widely. However, this changed, and a strong convergence can be seen from the year 2000 onwards. Former high-interest countries such as Spain, Portugal or Italy, as well as Greece, benefited from the integration of the capital markets and enjoyed similarly low interest rates as had previously the Deutschemark. This suggests that investors ignored the country-specific risks and regarded the countries in the EMU as equal in risk.

In the years leading up to the financial crisis, Europe and the USA initiated a phase of loose budget restrictions on a larger scale, from which the private sector, in addition to the governments, increasingly benefited. These capital flows provided GIPS countries such as Ireland and Spain with growth rates far above the Euro area average. Nevertheless, it was not the public sector that kept its level of debt or even reduced it, but rather the private sector that accumulated large amounts of debt prior to the financial crisis of 2007.

Figure 4. Gross State Debt as a Share of GDP in Selected European Countries

Abbildung in dieser Leseprobe nicht enthalten

(Eurostat, own representation)


Excerpt out of 23 pages


The European Dept Crisis. Why it occured and what we can learn of it
Maastricht University
Catalog Number
ISBN (eBook)
ISBN (Book)
Finance, European Sovereign Debt Crisis, Bachelor Thesis
Quote paper
Christian Block (Author), 2019, The European Dept Crisis. Why it occured and what we can learn of it, Munich, GRIN Verlag,


  • No comments yet.
Read the ebook
Title: The European Dept Crisis. Why it occured and what we can learn of it

Upload papers

Your term paper / thesis:

- Publication as eBook and book
- High royalties for the sales
- Completely free - with ISBN
- It only takes five minutes
- Every paper finds readers

Publish now - it's free