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The Eurozone responded decisively to the outbreak of the 2008 financial crisis and global recession. The unity and cohesion of EMU members in facing the crisis with one voice was clear. As the European Commission put it at the time: ‘we sink or swim together’. In 2008, the exceptional circumstances of the 2005 revised Stability and Growth Pact (SGP) were invoked by member states as an imperative tool to combat the crisis. Determined to prevent negative spillovers across the Eurozone and mitigate the impact of the freeze in interbank lending, the ECB decided to set interest rates at an historical low level.
Additionally, in March 2009, it was announced that the European Economic Recovery Plan (EERP) would allocate 3 percent GDP (around €400 billion) to its twofold objectives of stabilizing the financial system and supporting the real economy. Among other decisive responses, the EMU leaders also decided to guarantee deposits of up to €100,000. The European concerted action in dealing with the crisis was praised. In an ECB paper, the bank highlighted the fact that the decisions taken by Eurozone leaders prevented a ‘spiral of financial sector “beggar-thy-neighbour” measures’ from escalating.
However, the policy shift that occurred in January 2010, when the European Council decided to stop their Keynesian programme and assure a return to “sound public finances”, inverted the recovery programme, triggering dire consequences for the future of the Eurozone. As a result, the flaws and shortcomings in the architecture of EMU become apparent. EMU was designed without an anti-crisis mechanism structure. The ECB statute does not allow it to be a lender of last resort, for it forbids the ECB to buy government bonds in the primary markets. Further, EMU’s no-bailout clause left Greek sovereign bonds open to speculation and the discretion of the financial markets. The lack of an anti-crisis mechanism ready to be activated in the event of an international financial crisis, together with the Eurozone’s failure to realize that negative spillovers could be spread to the entire Eurozone, placed EMU with an existential problem and at the brink of collapse.
Facing similar market pressure, Ireland and Portugal were forced to join Greece and request a bailout. The rise of borrowing costs to Italy and Spain in 2012 further demonstrate that EMU leaders failed to understand the impact of contagion, leaving EMU near to collapse once again. This was exposed further when Greece’s second bailout haircut a few months later left the Cypriot banking sector vulnerable to those haircut losses. Additionally, the Eurogroup’s decision to support a Cyprus proposal to breach the €100,000 deposit guarantee demonstrates a clear failure in EMU’s management, for it led to capital flights and consequently to the imposition of capital controls in Cyprus.
This decision breached at least one fundamental pillar of EMU - the free movement of capital among its member states. Due to the reluctance of Eurozone governance to accept responsibility for the failure of these “beggar-thy-neighbour” policies, the tensions between northern and southern members of EMU have taken a dangerous path. Different views in both the diagnosis and the measures to control the sovereign debt crisis are at the centre of the divergences: whereas the north takes the crisis to be originated from southern profligacy, thus suggesting austerity and structural reforms as appropriate measures to solve the crisis, the south take the view that it was precisely the change from demand to supply side policies that triggered and is intensifying the sovereign debt crisis, thus suggesting that policies focused on growth are the most adequate to resolve the crisis.
But one thing is certain: the sovereign debt crisis demonstrated that using fiscal stimulus to ignite economic recovery in an monetary union built without a full fiscal union, deprived of a lender of last resort, fiscal transfers or Eurobonds, and lacking the structure to activate an anti-crisis mechanism, has resulted in systemic banking stress, capital flights, intense market pressure and raised the government bonds to unsustainable levels in the periphery while at the same time decreasing interest rates in the north. Therefore, it was the inadequate structural framework of the Eurozone - not Keynesian policies – that fuelled the sovereign debt crisis.