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Towards a consensus on the causes of the EZ Crisis

The EZ Crisis is a long way from finished. The latest VoxEU eBook presents a consensus view of what caused the Crisis and why. It argues that this was a classic ‘sudden stop’ crisis – not a public-debt crisis. Excessive, cross-border lending and borrowing among EZ members in the pre-Crisis years – much of which ended up in non-traded sectors – was why Greece’s deficit deceit in 2009 could trigger such a massive crisis. The ultimate causes were policy failures that allowed the imbalances to get so large, a lack of institutions to absorb shocks at the EZ level, and poor crisis management.

The Eurozone Crisis which broke out in May 2010 is half a decade-old and a long way from finished. Mainstream forecasts predict that hundreds of millions of Europeans will miss out on the opportunities that past generations took for granted. The burden is falling hardest on Europe’s youth (Commission 2015).

But this is no longer just an economic crisis. The economic hardship has fuelled populism and political extremism. In a social and international setting that is more unstable than any time since the 1930s, anti-European rhetoric is becoming mainstream. Parties arguing for breaking up the Eurozone and the EU are no longer found only in the political fringe.

Worse yet, there is a widespread belief that the fragilities and imbalances that primed the monetary union for this crisis are still present.

As a first step to finding a broad consensus on what more needs to be done, we gathered essays from 20 world-renown economists on a simple question:

  • “What caused the Eurozone Crisis?”

The eBook which we launch today: The EZ crisis: A consensus view of the causes and a few possible solutionspresents their views. This eBook focuses on causes since ‘if you don’t know what is broken, you don’t know what to fix.’

A consensus emerges: It was a ‘sudden stop’, not a public debt crisis

Although the essays were largely uncoordinated – and the authors have diverse backgrounds – a remarkably coherent message emerges from this collection of essays.

  • Excessive, cross-border foreign lending and borrowing among EZ members in the pre-crisis years – much of which ended up in non-trade sectors – was why Greece’s 2009 deficit deceit could trigger such a massive crisis.

At its core, this as a classic ‘sudden stop’ crisis – not a public debt crisis.

Some of the intra-EZ lending and borrowing in the 2000s went to private borrowers (especially in Ireland and Spain) and some to public borrowers (especially in Greece and Portugal). When trust evaporated in 2010 and 2011, most of it ended up in governments’ hands. As EZ governments cannot devalue or force their central bank to finance public debt, Eurozone members who relied heavily on foreign lending had to be bailed out. 

The ultimate causes of the EZ Crisis were thus:

  • Policy failures that allowed the imbalances to get so large;
  • Lack of institutions to absorb shocks at the EZ level; and
  • Crisis mismanagement.

The imbalances at the eve of the crisis

The linchpin of the EZ vulnerabilities stemmed from the build-up of large current-account imbalances. There is nothing intrinsically wrong with such flows. If the borrowed funds are invested in capacity, that helps pay back the loans. To a large extent, this was not the case. In Greece, Ireland, Portugal, and Spain (the GIPS for short, or GIIPS if it includes Italy) the funds ended up in various non-traded sectors. 

The first column of Table 1 shows the cumulated imbalance from the euro’s inception till the last year before Lehman Brothers went down in flames. The numbers for Greece, Cyprus, Portugal, and Spain are enormously negative. This meant that these nations were investing far, far more than they were saving and implicitly financing it via foreign borrowing. Of course, all of this was the outcome of open markets. None of the governments were involved systematically in the foreign borrowing or lending.

On the creditor side, the figures are high but not quite as high for the large core nations – Germany, France, and the Netherlands. Italy, interestingly, is only modestly negative during these years at -8%.

The second column shows that for some of these nations, the inflow of foreign capital was implicitly financing budget deficits. In Greece and Portugal the large negative numbers in the first column (foreign borrowing) are matched by large negative ones in the second column (government borrowing). The large cumulative deficits stand out for Spain and Portugal, but even Germany and France had cumulative public borrowing on the order of 20 percentage points of GDP over this period. Italy’s was on a similar scale, although a bit higher. On the surplus side, Finland and Luxembourg have unusually large numbers.

Plainly, a great deal of public debt was being created during the Eurozone’s peaceful years. But the good growth during this period resulted in falling debt burdens in most Eurozone nations. For reference, the endpoint government debt-to-GDP ratio is shown in the final column.

The third and fourth columns of Table 1 show the increase from 2000 to 2008 in bank assets as a fraction of GDP, and the asset-to-GDP ratio on the cusp of the crisis, respectively. The numbers are remarkable.

  • Ireland’s banks added almost 4 times the nation’s GDP;
  • Austria’s banks added 2.5 times GDP.
  • Spanish, Belgian, and French bank assets rose by over 100%.

Table 1. Summary of pre-crisis imbalances

Source: IMF and European Banking Association online data with authors’ elaboration.

By 2007, many banks were not only too big to fail, but they were also too big to save (Gros and Micossi 2008). Ireland’s banks had assets (and thus loans) worth seven times Irish GDP. The core economies were not much better with their banks holding more than twice their nation’s GDP. The figures were over three times for Germany, France, and the Netherlands. Luxembourg’s number was astronomic.

The key point here is that the programme nations were the ones with large current-account deficits – not the ones with the largest public debt, largest cumulative government deficits, or largest bank debt accumulation.

When investors turned cautious, they stopped lending to foreigners. Thus, nations who were net lenders, like Belgium, were OK despite their massive debt-to-GDP ratio and huge bank debts. 

Going forwards

This eBook is a first step in a bigger project called ‘Rebooting Europe’. It seeks to marshal a critical mass of Europe’s best thinkers in developing ways to get Europe working again; and to undertake a systematic rethink of today’s European socio-economic-political system. In short, to figure out a way to update Europe’s ‘operating system’ and reboot.


Baldwin, R and F Giavazzi (eds.) (2015), The Eurozone crisis: A consensus view of the causes and a few possible solutions, VoxEU.org, September.

Commission (2015), “Spring 2015 Economic Forecast”, European Commission, DG EcFin.

Gros, D and S Micossi (2008), “The beginning of the end game … ”, VoxEU.org, 20 September.

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