Sovereign debt crisis contributed to the Eurozone’s unemployment

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The sovereign debt crisis

A sovereign debt crisis is a situation where economic and financial problems are caused by a country’s inability to pay its public debt. This usually happens when a country reaches critically high debt levels and suffers from low economic growth.

Public Debt percent of GDP

The European sovereign debt crisis started with the collapse of Iceland’s banking system in 2008. The crisis spread to Greece, Ireland, and Portugal in 2009. The European sovereign debt crisis added to the economic woes of the PIIGS (or Portugal, Italy, Ireland, Greece, and Spain) nations. It also impacted the performance of exchange-traded funds (or ETFs) like the Vanguard FTSE Europe ETF (VGK), the iShares MSCI EMU Index Fund (EZU), and the SPDR EURO STOXX 50 ETF (FEZ). These ETFs track European equities. VGK invests in companies like Novartis AG (NVS) and HSBC Holdings Plc (HSBC).

The fallacy of a monetary union

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The trouble with the Eurozone economies basically lies in their monetary union—the use of a single currency—”the Euro.” All of the 18 nations use the Euro. It’s printed, issued, and controlled by the European Central Bank (or ECB). The Eurozone nations have no power over the currency. In times of financial distress, when the countries need to pump liquidity into their economies, they can’t print money. They can only borrow more money from the ECB. This is the fallacy of a monetary union.

Sovereign debt crisis contributed to unemployment

The sovereign debt crisis in the Eurozone contributed to the rise in unemployment. It affected the two tools of macroeconomic stabilization—monetary and fiscal policy.

  • Monetary policy – Despite very low policy rates, the cost of capital actually increased in stressed countries during the the sovereign debt crisis. As a result, the monetary policy focused on repairing the monetary transmission mechanism. The economic slowdown allowed unemployment to increase.
  • Fiscal policy – Although public administration, education, and healthcare were positive for employment in all of the countries during the first phase of the crisis—from 2008 to 2011—the trend reversed in the second phase—since 2011. Debt sustainability concerns took over as sovereign debt restructuring discussions started. As a result, the necessary fiscal consolidation—strategies that are aimed at minimizing deficits while also curtailing the accumulation of more debt—created a fiscal drag. It was supposed to restore investor confidence. There was also a downturn in public sector employment. This added to the unemployment concentration in all of the sectors.

Mario Draghi also described the cyclical and structural factors that contributed to the current unemployment situation in the Eurozone. Continue reading the next parts in the series to learn about the cyclical and structural factors.

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