“Discuss the causes of the sovereign debt crisis in Europe since 2008 and critically analyse the proposed responses. It is important that you inform your arguments using academic literature.”

Introduction

The European sovereign debt crisis came to prominence in late 2009, when newly elected Greek Prime Minister George Papandreou announced that previous governments had been distorting the country’s deficit data (Nelson et al., 2012). A revision of the budget deficit forecast was revealed as 12.7% of GDP – a valuation that was almost double the previous figure of 6.0% (Gibson et al. 2012). The reaction to this was a fall in investor confidence, which caused sovereign bond yields to rise to an all-time high (see Appendix 1). This impacted not only Greece, but also other heavily indebted countries within the Eurozone – identified as peripheral nations (Greece, Ireland, Italy, Portugal and Spain).

There is growing concern within the Eurozone that these periphery nations could ultimately default on their sovereign debt. European banks currently hold a large portion of the regions government bonds (see Appendix 2); if one nation was to default on its sovereign debt payments it would cause financial pressure throughout the Eurozone (Constâncio 2012). This is a known as financial contagion, a term described by Dornbusch (2000) as the spread of market shocks from one country to another. The fear of contagion has forced the European Central Bank (ECB) to bailout a number of the periphery nations; however, this is not viewed as a sustainable practice. The aim of this essay is to identify the causes of the sovereign debt crisis and analyse the proposed responses by the European Union (EU).

Causes