Understanding the euro crisis: lessons for future policy-makers

BBC Online recently produced an informative presentation entitled ‘What really caused the eurozone crisis?’ Taking the reader through a number of key steps and moments, it shows in impressive detail how the eurozone has arrived at the present impasse, and finishes by offering some suitably depressing suggestions as to how it all may end.

However, because it tells only part of the story that has unfolded since 2008, the Corporation’s presentation ultimately gives us an unconvincing answer to the question it asks. The answer it gives is that ‘there was a big build-up of debts in Spain and Italy before 2008’, but that ‘it had nothing to do with governments’. We are informed, rather, that this potentially disastrous build up of debt was caused by behaviour in the private sector. 

Now, there is of course a certain sense in which all of this is true. The problem, however, is that it is only a part of the truth. To see why, we need to look a little more closely at what the BBC does and does not say. It explains, rightly, that interest rates had fallen to unprecedented lows in southern European countries when they joined the euro in 1999 (Greece in 2001), thus prompting a massive build-up of debt in the private-sector. Crucially, though, it fails to tell us how rates had come to be so low.  The fact of the matter is that, contrary to the BBC’s central assertion that governments had nothing to do with this, it was either these countries’ own governments, or their independent central banks, that set interest rates prior to joining the euro. 

In either case the conclusion one should draw is the same. In the case of interest rates being set by governments, and in direct opposition to what the BBC tells us, this quite clearly does imply that governments had a lot to do with causing the debt, by structuring the generic monetary conditions that facilitated its emergence. Similarly - and perhaps whilst not a governmental decision in the strict sense - it would be odd to describe the decisions of an independent central bank as anything but public in nature, again undermining the presentation’s central claim that these debts have only been caused by behaviour in the private sector. Of course, making the government and public sector’s role clear in this way would not only seriously undermine the claim that the eurozone crisis is a problem that was born in the private sector. It would also demonstrate the extent to which the private sector’s role was largely reactive in nature, rather than the proactive one that the BBC would have us believe.

There is a similar lacuna in the analysis if one looks at what happened since countries such as Spain and Italy joined the euro. But, before doing this, there is another crucial piece of the puzzle which the BBC’s presentation fails to consider, and which undermines yet again the idea that governments had nothing to do with the eurozone crisis. The decision to join the euro was itself a decision that could only be taken by governments. So it is to the actions of states and their governments that we must look when it comes to deciding the character of the generic conditions within which private actors then go about their business. Beyond this, the consequence of the decision to join the eurozone has not only been that interest rates in the southern nations have since have remained low, as the presentation points out. This decision has of course also meant that member nations have since had their interest rates set for them by the ECB. And here we encounter an additional contributory cause to the crisis that the BBC does not tell us about. One of the key consequences of membership of the euro has been that interest rate decisions that may actually have helped to reduce debt in the PIIGS were unavailable to them because of economic conditions in other members such as Germany. It is to the centralised monetary mechanics of the eurozone, and how these too have contributed to the present crisis, therefore, that the BBC should also have paid close attention, so that the public had a more accurate picture of events.

What, then, should we conclude from this? It is clear that the claim that the eurozone crisis had nothing to do with governments is misleading to say the least. In the absence of a privatised currency system, the private sector’s role is largely reactive to what governments and other public entities decide to do. Conversely, that governments and non-private sector actors have and continue to play a major role in the emergence of these grave problems is as obvious as it is crucial to understand.  Indeed if, as politicians, policy-makers and citizens, we are interested in avoiding such crises in the future, it would be a very good start to understand that it is to the interaction between the private and public sectors, under conditions that are largely determined by the latter, that we should pay close attention. 

Dr. Adam Tebble is a lecturer in political theory at King's College London and is the author of Hayek.   

Another possible political factor is the moral hazard arising from the presumption that some banks are 'too big to fail' and will if necessary be bailed out by the government, inducing them to make riskier loans than otherwise. This seems to have been a major factor in the US. Was it so important in the eurozone?
But, it goes even further than this. Let's suppose that there were extremely high private sector returns to capital in the private sector in Spain (to take one example). A unified currency area would lead to more mobility of capital (no currency risk) and capital would enter the country where it was relatively scarce (and the fact that there may have been a "speculative bubble", or that monetary policy was too loose across the eurozone as a whole and so on, does not change the nature of the argument). The response to this is general inflation in Spain relative to the rest of the zone - especially in the sectors into which the capital is flooding. In a fixed exchange rate regime, this has the equivalent effect of the exchange rate appreciation you would expect to see if exchange rates were floating. Now this all reverses (for whatever reason). You now need to have rapid pricae adjustment in the country from which capital is flowing (say, Spain). But such price adjustments are impossible because of highly rigid labour and product markets. In a floating rate system the price and living standards adjustment would happen through depreciation of the currency. You cannot stop economic shocks from happening or changes in economic conditions and perceptions of investors. It is not the private sector's "fault" that these things happen. The EU members chose to, though, close off all possible mechanisms of adjustment - currency movements and wage and price movements. You either have a single currency in the context of liberal labour markets that allow nomiinal wages to fall or you do not have a single currency. It is the politicians that chose to impose a single currency on a "non-optimal area" whilst ensuring that there would be no mechanism to facilitate economic adjustment.

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