Euro-area crisis

The euro-area crisis burst at the end of 2009, when the newly elected Greek government discovered and announced that the Greek public deficit and debt were much higher, with respect to GDP, than the previous government had claimed. During 2010 a number of euro-area countries in the periphery of that area (Ireland, Portugal and Spain) came under much pressure, because financial markets participants feared that these countries' governments in one way or another were going to default and exit euroland. These pres- sures then extended to Italy as well, in light of its high public debt-to-GDP ratio and a rate of GDP growth close to zero. All these countries have thus been subsumed under the acronym "PIIGS" (formed by their initials), to convey the idea that their financial problems originate in their behaviour, characterized by a profligate fiscal policy and expenditure levels beyond available income.

The euro-area crisis is indeed considered to be a "sovereign debt" crisis, which, if it were the case, would mean that it is a crisis generated because of excessive public deficits and debts in a number of its member countries. In fact, apart from Greece, this view is wrong as regards the situation of the general government sector. As a matter of fact, in Ireland and Spain the situation of the public sector was not problematic (according to the famous Maastricht criteria about public finance) until the real-estate bubble burst in 2008. Owing to the increased fragility of many banks and non-bank financial institutions in these countries as a result of the bursting of the housing bubble, the general govern- ment sector had indeed to intervene in their support, and in order to avoid a banking crisis whose systemic effects would have devastated the whole domestic economy.

The problematic situation of the "PIIGS" raised dramatically the spreads between the rates of interest on their governments' bonds and the yield of German government bonds, used as a benchmark to assess the quality of public sector borrowers. This upward pressure on these spreads further aggravated the situation in the countries concerned, thereby worsening the euro-area crisis and raising more doubts about the viability of the single currency area. The European Central Bank (ECB) had therefore to intervene on several occasions, first with its decision to reduce policy rates of interest in an attempt to reduce the spreads and to increase confidence on the interbank market, then with a series of unprecedented purchases of bonds on the secondary market for "sovereign debts". Known as the "Securities Markets Programme" (SMP), this intervention by the ECB occurred in public and private debt securities markets within the euro area, to restore their liquidity in order for the ECB monetary policy to work smoothly throughout that area. This intervention has been sterilized by the ECB, in order to avoid increasing the volume of bank deposits with euro-area banks, which in the ECB's view would have exerted an upward pressure on expected inflation rates, thereby putting its price stability goal at stake.

In light of the insufficient effects of the SMP, the ECB decided to implement Longer- Term Refinancing Operations (LTROs), through open-market operations whose matu- rity exceeds three months and has actually been extended to three years. LTROs were carried out for a total amount of approximately 1 trillion euros, between December 2011 and February 2012. These LTROs represent a form of credit easing (since the credit standards adopted by the ECB were edulcorated and the list of eligible assets included a number of "junk bonds") and have been assimilated to quantitative easing (QE) carried out by the Federal Reserve in the United States from 2008 in three different steps (named QE1, QE2 and QE3). As the LTROs of the ECB were unable to induce banks to support economic growth via their lines of credit to non-bank agents (who refrained from enter- ing into debt in light of the recession that has been hitting the euro area since the erup- tion of the crisis), the ECB decided to show its "bazooka" to financial markets in the summer of 2012: its President announced that, within its mandate, "the ECB is ready to do whatever it takes to preserve the euro" (Draghi, 2012a), a promise that he put into practice on 6 September 2012 when he said that the ECB had decided about "undertak- ing Outright Monetary Transactions (OMTs) in secondary markets for sovereign bonds in the euro area" (Draghi, 2012b). With this new tool, the ECB stands ready to buy an unlimited amount of "sovereign bonds" with a maturity of one to three years, hoping thereby to influence the shorter part of the yield curve (European Central Bank, 2012). OMTs replace the SMP, which is thereby terminated, and are to be sterilized, to avoid putting upward pressure on (expected) inflation rates.

On the whole, the euro-area crisis shows that a single monetary policy for a structurally and economically different series of countries does not work properly, as its supposed "one size fits all" is but a figment of the central bankers' imagination. The euro-area crisis shows, as a matter of fact, that the ECB cannot make sure that its monetary policy affects the whole area in such a way as to guarantee financial stability and to contribute to eco- nomic growth in an environment of stable prices on any kinds of markets (including real and financial assets). It also shows that central bank independence should not be consid- ered as being incompatible with supporting the fiscal policy of the general government sector. In fact, monetary policy is part and parcel of the set of economic policies that should be coordinated and aimed at a series of policy goals that contribute to enhance the prosperity and well-being of all stakeholders.

See also:

Bank deposits; Central bank independence; European Central Bank; European mon- etary union; Financial crisis; Financial instability; Housing bubble; Long-term refinanc- ing operations; Open-market operations; Outright Monetary Transactions; Quantitative easing; Sterilization; Yield curve.