Introduction

The popular understanding of the Eurozone crisis is that various periphery Eurozone governments overspent and as a result found it difficult to sell their debt on the markets. During the crisis the media would ask whether measures being taken to reduce budget deficits were enough to convince the markets. This completely failed to see why the crisis happened in the Eurozone and not elsewhere.

To understand the Eurozone crisis you need to know how it ended. In September 2012 the European Central Bank (ECB) introduced OMT (outright monetary transactions). OMT was in essence an unlimited commitment to buy the debt of particular countries: to be what economists call a lender of last resort. What created the Eurozone crisis between 2010 and 2012 was the ECB’s refusal to act as a lender of last resort to individual Eurozone governments.

Governments with their own central bank cannot be forced to default by the markets, because the central bank will step in and buy any unsold debt. As I described in the first post of Chapter 1, in the UK the Bank of England did this as part of its unconventional monetary policy. For institutions and individuals lending to these governments, having the central bank as the lender of last resort removes the risk of a forced default. Even if the rest of the market fails to buy the debt, the government will not be pushed into default.

In contrast, as long as the ECB refused to act as a lender of last resort to Eurozone governments, Eurozone government debt was much riskier and much more susceptible to market panic. So the crisis started by Greece (which really did borrow too much) was allowed to spread to other countries where public finances were sound. Once OMT was put in place the crisis quickly subsided, and did not start up even when Greek default again became possible in 2015. As Post 2.1 shows, these points were understood well before OMT was introduced.

The consequences of the delay in introducing OMT were immense. Austerity occurred in all Eurozone countries, not just the periphery, with large costs in terms of a second recession and lost resources, as outlined in Post 2.6.