Although 2010 and 2011 saw the beginnings of a recovery from the global economic crisis, driven primarily by growth in emerging markets, the simmering sovereign debt crisis in the Eurozone still looms large – and could even spark a renewed global financial crisis. What were the roots of Europe’s sovereign debt crisis? How important was the global financial crisis to the evolution of that crisis, and how important were factors internal to the Eurozone, especially the adoption of the euro?

The European crisis reflects primarily the reaction of financial markets to overborrowing by private households, the financial sector, and governments in noncore Eurozone countries. The crisis led to economic adjustment programs, sponsored by the European Union and the IMF, in Greece, Ireland, and Portugal. Many analysts – along with the public in some core countries – blame the European debt crisis on fiscal profligacy in noncore Eurozone countries, driven primarily by the expansion of a welfare state model and rising public sector wages. If countries had balanced their budgets and avoided the temptations of a welfare state, this view claims, there would have been no excessive private spending, and investors and banks would have been more aware of the risks. That being the case, noncore countries should renounce their welfare objectives and adopt a more realistic fiscal policy. In this view, such fiscal discipline would strengthen the euro without the need for more fiscal stimulus. Germany strongly endorses fiscal austerity for ending the crisis. Under Germany’s leadership, the G20 summit in Toronto in June 2010 established fiscal consolidation as the new policy priority.