Euro on the Verge of Collapse

In the autumn of 2011, the European sovereign debt crisis reached a pitch of intensity that had serious economists and policymakers openly contemplating what had previously been unthinkable: the possible dissolution of the eurozone.

The crisis had its roots in the global financial collapse of 2008, which exposed the fiscal vulnerabilities of several eurozone member states. Greece, which had borrowed heavily and misreported its deficit figures, was first to require a bailout in 2010. Ireland, whose government had guaranteed the debts of its catastrophically over-leveraged banks, followed. Portugal was next. By late 2011, contagion had reached the big ones: Spain and Italy.

November 2011 was the crisis's darkest month. On October 31, Greek Prime Minister George Papandreou stunned Europe by calling a referendum on the bailout terms — then withdrew it within days and resigned; Lucas Papademos took over on November 11. In Italy, Silvio Berlusconi resigned on November 12 as the country's 10-year bond yields surged past 7 percent, the level at which Greece, Ireland, and Portugal had all been forced to seek bailouts. Mario Monti, an economist and former EU commissioner, was appointed to lead a technocratic government on November 13.

The fundamental problem was structural. The eurozone shared a currency but not a fiscal union. Member states could not devalue their currencies to restore competitiveness, as countries with independent monetary policy can. They were also bound by Maastricht Treaty deficit limits that constrained fiscal responses. And the European Central Bank's mandate was narrowly focused on price stability, not on functioning as a lender of last resort in the way the Federal Reserve does for the United States.

The prescription of austerity — severe cuts to government spending in exchange for bailout funds — generated enormous political and social resistance. In Greece, the anger at both domestic politicians and European creditors produced street protests and political instability. Similar dynamics played out in Spain and Portugal.

The euro did not collapse. A combination of ECB policy shifts — culminating in Mario Draghi's "whatever it takes" pledge of July 2012 — political commitment from core eurozone members, and restructuring of Greek debt eventually stabilized the situation. But the crisis permanently altered the politics of European integration and left unresolved the fundamental design questions about monetary union without fiscal union.