Eurozone crisis: What it means and how it affects world economy

Last Updated: Jan 03, 2012, 15:08 PM IST

Akrita Reyar

Eurozone crisis was one of the most used terms through 2011, but few really comprehended what the debt crisis was all about. So here is a simple Q&A to cut through the jargon.

What is the Eurozone crisis?

Also known as Eurozone debt crisis or Eurozone sovereign debt crisis, the term indicates the financial woes caused due to overspending by some European countries. Just like an individual, when a nation lives beyond its means by borrowing heavily and spending freely, there comes a point when it cannot manage its financial situation. When that country faces insolvency i.e. when it is unable to repay its debts partially or fully and lenders start demanding higher interest rates, the cornered nation begins to get swallowed up by what is known as the Sovereign Debt Crisis.

Meanwhile, the term Eurozone indicates the combined region of 17 European countries that use Euro as their common currency. Currently Eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

The monetary policy of the zone is the responsibility of the European Central Bank (ECB) which is governed by a board comprising heads of national central banks.

Which all countries are most affected by the Eurozone crisis?

Greece is the country that has probably been the worst hit. Its debt had been spiraling even when it had not adopted the Euro as currency. A switch of currency only compounded the problem and opened the possibility of impact on other European countries.

Besides Greece, Ireland, Portugal, Italy and Spain are among the countries facing financial crisis.

What is the impact of a Sovereign Debt Crisis and why is the entire Eurozone threatened?

A country embroiled in a Sovereign Debt Crisis may see the crumbling of its banking system, flight of investment and currency collapse. An economic crisis inevitably leads to lay-offs, closure of businesses, shrinking purchasing power and financial hardship for citizens.

Europe has a unique system wherein 17 odd countries use a common currency. However the challenge is that different countries with varying levels of economic development and financial stability share the same money A situation of crisis in one has a ripple effect and can cause destabilization of the entire region. It is for this reason that countries like France and Germany with stronger economies have crafted bailouts for Greece.

How did the Eurozone debt crisis impact financial markets?

The Eurozone debt crisis impacted market sentiment. Investors became wary of putting in money into anything that seemed risky. The idea then was to invest in safe options like government bonds of finically sound countries. Overall, European bank stocks performed badly as did the bond markets of affected states, both of which had a negative effect on global markets.

What are the remedial measures being taken?

The first and the obvious reaction to the debt crisis has been ECB’s plan to inject liquidity into financially unstable countries. Emergency loans have been extended as bailouts mainly by stronger economies like France and Germany, as also by the IMF.

The EU member states have also created the European Financial Stability Facility (EFSF) to provide emergency loans. The ECB has promised to purchase government bonds, if necessary in order to keep yields at bay.

Besides there has been a restructuring of the debt i.e. to let the crisis unfold in an organized and predictable fashion than allowing an erratic collapse.

The problem with countries like Italy and Spain is that their economies may be too large to be bailed out.

Austerity measures have been enforced. These, unfortunately, come with some harmful side-effects. While austerity is highly advocated for countries facing a financial crisis, the dilemma is that slowdown of spending would adversely affect growth rates which will also come down. Slow growth or negative growth in turn means shrinking incomes and jobs, which only go on to aggravate the crisis. So it’s a bit of a Catch 22.